China: The Patient Is Not Responding - What This Means For Global Growth


  • China money supply growth is at historically depressed levels.
  • Typically, lower interest rates lead accelerations in money supply growth.
  • Too much debt has likely reduced the efficacy of monetary policy transmission.
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China: The Patient Is Not Responding - What This Means For Global Growth

Changes in various monetary aggregates are often the earliest leading indicator that monetary policy (tightening or easing) is flowing through the economy. This is a concept that we detailed in a note earlier this week.

As central banks ease monetary policy and lower interest rates, within several months, money supply growth often starts to accelerate, fueled by easier conditions, the first sign that economic growth may start to inflect higher. Changes in money supply growth can often lead inflections in more commonly followed economic data by over a year.

As economies become more indebted, central bank policy loses its efficacy in a concept often referred to as "pushing on a string." Central banks are trying to ease conditions, but some monetary aggregates are unresponsive. Luckily, this is not the case in the United States (yet) as money supply growth started to inflect after the Federal Reserve shifted from rate hikes and "QT" to rate cuts and "New QE." China, however, may have a problem of its own.

Since the start of 2019, "China Stimulus" was an overused talking point.

Ironically, despite the headlines, the stimulus is not apparent in the rate of Chinese money growth. Moreover, the rate of money growth in China is sitting at one of the lowest levels since reported data is available.

As the chart below shows, each time China embarks on a massive round of monetary stimulus, money supply growth responds; namely 2008 and 2015.

Today, money supply growth is unresponsive.

China Money Supply Growth:

China Money Supply Growth

Source: Bloomberg, EPB Macro Research

Even more troubling is that historical correlations that suggest China's money supply growth should be soaring have broken.

Typically, lower interest rates lead to accelerating rates of money supply growth. The chart below shows the 24-month change in Chinese 10-year bond rates (inverted) and the rate of money supply growth. This longstanding correlation suggests China's money supply growth should have already inflected higher, yet the gap is widening, and money supply growth remains muted.

China M1 Growth Not Following Interest Rates:

China M1 Growth

Source: Bloomberg, EPB Macro Research

While the break in the historical correlation may be surprising, the fact that China may be at their "pushing on a string" moment is less of a shock.

Economist Lacy Hunt measures the diminishing marginal returns of debt by monitoring the 10-year change in the amount of GDP generated for each dollar of debt.

For example, in the chart below, from 2007 to 2009, the United States generated $0.43 of growth for each dollar of debt. Over the past two years, debt in the US has become about 6% less effective, dropping to a rate of $0.40 of growth for each dollar of debt.

It should be noted that the US currently has the best ratio of GDP to Debt in the developed world, indicating that the global economy is likely to act as a drag on the United States.

China, on the other hand, has seen the effectiveness of debt collapse by nearly 40% in the last ten years. This development is rather unsurprising, given the unprecedented addition of unproductive debt plaguing the Chinese economy.

Diminishing Returns of Debt:

Global Growth Slowing Debt

Source: Hoisington Management, Lacy Hunt

China is a large part of the global economy, and the last round of stimulus in 2015 lifted the global economy for over two years before a deleveraging caused a major synchronized slowdown.

Graphed below is the GDP weighted rate of global money supply growth. China's contribution to global growth is large, and a lack of monetary acceleration has resulted in a lackluster pickup in global money growth.

GDP Weighted Global Money Supply Growth:

Global Growth Rebound

Source: Bloomberg, EPB Macro Research

In 2015, global money supply (GDP weighted) was increasing at 7.13% year over year. This is noted by the first red diamond. By February of 2016, when the US stock market bottomed after a recessionary growth scare, global money supply growth had increased 47% to 10.49% year over year (orange diamond). The official pickup in coincident economic data and bottom in US bond yields did not occur until the middle of 2016 which came with a 59% increase in global money growth compared to the bottom in 2015 (green diamond).

Today, global money supply growth is increasing at 5.14% year over year, only a 24% increase relative to the low point in early 2019.

As the GDP-to-Debt table above shows, the efficacy of global debt has declined by about 11% over the past ten years.

While central banks scramble to ease monetary policy enough to avoid a recession, their job has become increasingly difficult with less effective tools.

Even if a recession is avoided, which remains an open question pending the slowdown in US employment growth, the next upturn in global growth is set to be significantly weaker compared to 2016-2018 based on the acceleration (or lack thereof) in global money supply growth.

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This article was written by

Eric Basmajian profile picture
Tracking Economic Inflection Points To Guide Your Asset Allocation Strategy

Eric Basmajian is an economic cycle analyst and the Founder of EPB Macro Research, an economics-based research firm focusing on inflection points in economic growth and the impact on asset prices.

Prior to EPB Macro Research, Eric worked on the buy-side of the financial sector as an analyst at Panorama Partners, a quantitative hedge fund specializing in equity derivatives. 

Eric holds a Bachelor’s degree in economics from New York University.

EPB Macro Research offers premium economic cycle research on Seeking Alpha. 

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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