China Draws Nearer to Liquidity Trap

Published on Author Walker Helvey

China reported a capital outflow of $118 billion at the end of 2014.

Capital Outflows

The flow of cash out of the country is problematic because it lowers liquidity: the amount of money that is readily available for domestic lending and borrowing purposes. China appears dangerously close to falling into a liquidity trap: a state where cash hoarding renders adjustments to interest rates unable to spur the economy.

State-owned enterprises in the industrial sector have been producing more than the economy demands, resulting in an overall decrease in prices. The price reduction has made it difficult for these SOE’s to pay back loans, effectively raising borrowing costs. To top things off, Chinese consumers aren’t buying, and growth in disposable income has slowed in recent years.

The recent weakening of the Chinese economy has prompted two money-loosening actions by the People’s Bank of China. The PBoC cut the reserve requirement ratio for banks, effectively freeing up 600 billion yuan for banks to lend, and also lowered the benchmark one-year interest rate on loans and deposits.

Such rate cuts are typically implemented to spur lending, but many are concerned that the recent actions of the PBoC reflect a growing fear that money in China is treacherously scarce, and that modifying the interest rate may not be a sufficient means of revitalizing the economy.


One Response to China Draws Nearer to Liquidity Trap

  1. Foreign exchange purchases are swapping RMB for dollars — the domestic exporter ends up with RMB, the Bank of China with US$. So cash doesn’t flow out of the country….rather it reinforces the surfeit of domestic funds.

    Before shouting “liquidity trap” it’s helpful to ask whether the deflation reflects short-term factors (bumper harvests, a global surfeit of oil) or a combination of “real” factors such as wages rising slowly.

    In any case, if the underlying issue is weak loan demand, then “easy” money helps little. As per Mr. Miller, is the government really all that concerned? Does it want local governments to launch more white elephant projects? His answer was “no” and “no”. Remember too that under financial repression deposit rates and thus borrowing rates are kept (artificially) low, so there’s not much scope to lower rates. More important would be expanding access, but that’s a matter of institutional capabilities that can’t be enhanced overnight. Finally, all this ignores what’s happening with shadow financing. For that, banks may not be what we want to look at.