Steve Hanke: Why China is in Trouble

Cato Institute's monetary economist Steve Hanke sees China's economy in trouble in the lens of money supply activities

The course of an economy is determined by the course of that economy’s money supply (broadly determined). The relationship between money growth and nominal GDP growth is presented in the accompanying chart. It is persuasive. Indeed, money, not fiscal policy, dominates.

As I listen to all the ad hoc conjectures about the state of China’s economy and its near-term prospects, I am astounded to never hear anything said about the most important determinant of nominal economic growth: the money supply. The second chart tells the tale. The picture is not a pretty one. China’s money supply growth rate has been slowing down since early 2012. It now is growing at an annual rate of about 10%, which is well below the trend rate of money growth: 17.06%. China is in trouble. Slower money supply growth means that slower nominal GDP growth is already baked in the cake.

I would add that China's money supply has been falling mostly due to deepening balance sheet constraints as shown below:

China's debt stock continues to ramp even as the economy has been slowing. In other words, China's economy has reached a point where debt has been a major factor in the stymieing of real economic activities. Or debt signifies the cause of the effect--the slowing economy.

And because of too much debt...as an old saw goes...you can lead a horse to the water but you can't make it drink.

So if the real economy can hardly absorb new credit to boost money supply, then the (political) answer has been to find an alternative source for this.

And that's the role played by the Xi Jinping Put or China's Frankenstein stock market as most of the recent credit growth has been funneled to support the stock market

To quote Barclays Research via the Zero Hedge: (bold mine)

New loans and M2 growth in July surprised to the upside, dominated by one-off measures to stabilise the stock market. RMB new loans totalled CNY1480bn in July, almost double expectations (consensus: CNY750bn, Barclays: CNY790bn). However, more than half of the new loans (CNY886bn from CNY-47bn in June) were extended to non-banking financial institutions, while household loans and non financial institutions loans both shrank to CNY275bn and CNY313bn, respectively (June: CNY458bn, and CNY860bn). This reflects the government’s stock market support measures in the past month, with bank lending to securities corporations soaring. As a result, broad money (M2) growth jumped to 13.3% y/y from 11.8% previously, while base money (M0) growth remained flat at 2.9% y/y. At the same time, the CNY loan balance growth was up notably at 15.5% y/y, from 13.4% in June 

And naturally, since issuing so much money leads to pressures on her currency's exchange ratio with the US dollar, hence, this week's devaluation.