Today’s Bloomberg reports that China instituted a new program of monetary stimulus:
China’s central bank unveiled a broad package of monetary stimulus measures to revive the world’s second-largest economy, underscoring mounting alarm within Xi Jinping’s government over slowing growth and depressed investor confidence.
But is this what actually happened? Here’s how the exchange rate for the Chinese yuan responded to Monday’s news:
Note that this is actually the yuan price of dollars, so the sharp fall indicated an appreciation in the yuan. The flat stretch is the weekend period, when markets were presumably closed.
I cannot be certain, but it looks to me like the markets initially treated the news as monetary stimulus, and then sharply reversed course. Michael Pettis has argued that China’s monetary policy has become intertwined with credit policy.
China’s financial system today and Japan’s then have been structured in ways such that monetary expansion results mainly in credit expansion that, for well-understood institutional reasons, is directed mainly into the supply side of the economy.
If so, the markets may have treated this as more akin to fiscal stimulus than monetary stimulus. Note that currencies generally depreciate when there is unexpected news of monetary stimulus, and currencies often appreciate on news of fiscal stimulus (at least in countries where there is little fear of fiscal default.) The Bloomberg article provides support for the view that this might have been credit easing more than monetary easing:
Those moves were followed by a slew of other announcements that fueled gains in China’s beleaguered equity market. The central bank chief also unveiled a package to shore up the nation’s troubled property sector, including lowering borrowing costs on as much as $5.3 trillion in mortgages and easing rules for second-home purchases.
Another article in Bloomberg suggested that China is in recession:
China now has all the symptoms of a “balance-sheet recession”: a protracted period of deflation, property market declines, and a debt overhang. And, just as in Japan, this has followed an amazing period of growth.
I don’t like the term “balance sheet recession”, as these are simply tight money recessions—periods of slowing NGDP growth caused by a tight money policy. The property price declines and debt overhang are a symptom of tight money. In a recent blog post, I suggested that China needed monetary stimulus. I suspect that what they got is closer to fiscal stimulus.
READER COMMENTS
Thomas L Hutcheson
Sep 25 2024 at 5:36am
By “fiscal stimulus” do you mean an increase in fiscal deficits offset by changes in monetary policy instruments so as to leave the outcome variable such as inflation or NGDP unaffected?
Scott Sumner
Sep 25 2024 at 12:27pm
Yes, but deficits are hard to define in an economy where you have massive state owned banks acting to lower mortgage rates in a non-market fashion. Does that lead to more (implicit) government debt? I’d say so, but it may not show up in the data.
Warren Platts
Sep 25 2024 at 7:12am
From Michael Pettis:
This is interesting because in China, monetary expansion is causing output to rise relative to demand — output its own citizens cannot afford to buy. This in turn will cause China to increase exports to the ROW, and hence the implication for the U.S. will be a rising trade deficit. Thus I wouldn’t place too much stock in a buy-on-rumor-sell-on-news yuan fluctuation of less than half a percent.
Craig
Sep 25 2024 at 7:33am
“We must prevent the foreign exchange market from forming unilateral, consistent expectations that could become self-fulfilling, and guard against the risk of exchange rate overshooting or over-adjustment,” he said.
Looks to me like PBOC saw the yuan depreciate and my guess is they then immediately intervened to support the currency.
Scott Sumner
Sep 25 2024 at 12:10pm
Interesting. That supports my skepticism about whether they really got monetary stimulus. I’d note that today they did a bit more, and the yuan seems to have fallen back a bit.
David S
Sep 25 2024 at 9:20am
I was hoping you would post on this topic. Is China making the same mistakes Japan made in the 90′ and 2000’s or are they making the same mistakes our Fed made circa 2006 to 2009?
How would David Hume evaluate PBOC policy moves?
Scott Sumner
Sep 25 2024 at 12:12pm
It seems a bit more like Japan in the 1990s, although there is still plenty of time for China to turn things around, so the Japan outcome is not inevitable.
The policy process is so complex in China that all I can do is look at the results.
Jim Glass
Sep 28 2024 at 5:12am
China’s issue is fundamentally different. Under Xi the regime is returning to hard Leninism (rehabilitating Stalin and denouncing Khrushchev for betraying Stalin — in our 21st Century that is hard Leninism.) The economic policies it has adopted in the last four years are Leninism 101, right down the line. There is no puzzlement about them at all once one realizes this.
In a ‘blackboard economics’ sense, certainly. Though there are a lot more problems in China than there were in Japan. And we’ll have noticed how high-level government economist Zhu Hengpeng just recently vanished after reportedly criticizing Xi’s economic policies in a private chat. The Japanese didn’t have that problem. And no blackboard offers any quick solution for: Leninist regime running the economy.
Laron
Sep 25 2024 at 7:18pm
Why would fiscal stimulus tend to cause a currency to appreciate?
Warren Platts
Sep 26 2024 at 10:59am
Right. Presumably, as Michael Pettis said, the stimulus in China mostly turns up on the supply side, thus increasing their trade surplus. That in turn will require China to acquire more foreign exchange assets that in turn will drive the worldwide demand for USD, thus strengthening the USD relative the RMB. If the fiscal stimulus showed up mostly on the demand side, as typical for the United States, I guess the effect would be the opposite?
Jon Murphy
Sep 26 2024 at 11:17am
Fiscal stimulus increases the demand for the currency in question, leading to its price to rise (appreciate).
Warren Platts
Sep 27 2024 at 8:33am
I think the point of the whole article is that: it depends. In China’s case, evidently, the monetary stimulus (and it is monetary) happens deflationary. That makes their products more desirable to importers and so their currency is revalues as imports acquire yuan to buy Chinese products. But if the stimulus was inflationary, one would expect the opposite effect.
Jon Murphy
Sep 27 2024 at 8:55am
And the point of Scott Sumner’s post is that it does not depend. Rudimentary economic theory helps us think through these things. Indeed, that’s the point of any scientific theory.
Theory is a lens though which we can see the world more clearly. Seemingly random events become crystal clear. Things that seem dependent on one variable end up being independent of that and dependent on others.
To go back to Laron’s question, simple supply and demand analysis helps us see the effect of fiscal and monetary policy on exchange rates. When the demand for money rises (fiscal stimulus), the price of money rises (the currency appreciates). When the supply of money rises (monetary stimulus), the price of money falls (the currency depreciates).
One needn’t come up with convoluted “what-ifs” when we have well-established theory that better explains the events witnessed with fewer assumptions.
Warren Platts
Sep 28 2024 at 3:24pm
That’s the thing, and what makes Scott’s article interesting: exactly the opposite of your prediction happened, thus falsifying your theory. The current batch of stimulus going on in China is monetary stimulus, yet the currency is (still) appreciating ($7.01 as of this weekend).
I know, Jon, you haven’t had much nice to say about Pettis in the past, but Michael’s article provides an important clarification of Milton Friedman’s (and Anna Jacobson Schwartz’s) famous quotation:
Friedman’s point only holds if a rise in the supply of money results in a rise in demand relative to output. If a rise in the supply of money instead causes production to increase relative to demand, you get deflation — and currency revaluation.
Kurt Schuler
Sep 25 2024 at 10:19pm
Scott, moving from analysis to prescription, what do you suggest that the Chinese government do? Are GDP figures reliable enough to try nominal GDP targeting, or do you think the government should do something with less potential for measurement error, such as such as depreciating the currency toward or to a certain exchange rate with the dollar?
Warren Platts
Sep 28 2024 at 6:56pm
Scott’s advice was for them to read Chapter 3 (“: The Princeton School and the Zero Lower Bound”) of his latest book on monetary theory. It’s free!
Jim Glass
Sep 28 2024 at 5:09am
Some data seen recently on China’s problems: Since 2021 its stock markets have lost $6.8 trillion of value, and housing has lost $18 trillion of value. That’s a pretty darn big hit to consumer purchasing power. Moreover, foreign direct investment has turned net out, negative, for the first time since recordkeeping.
What’s gone so wrong? Current lack of demand? Well, in part no doubt — but since Xi’s second term started back in 2017 we’ve seen defenestration of top business leaders (Jack Ma), crippling and killing of major industries (Alibaba, gaming, private education) , putting CCP cells into the boards of private corporations., forcing profitable private firms to merge into unprofitable state owned enterprises, the state slashing wages in the finance industry, and a lot more. … Then there are all the wolf warrior attacks on nations around the world (Norway and Sweden!) causing trading partners to divest due to security concerns … and of course the huge obsession with maximizing (over)investment to drive the economy — after the housing collapse, such (over)investment shifting into manufacturing. This overinvestment being fueled by financial repression of consumers to the extent that – as Pettis says – money stimulus for consumers effectively is channeled to boost producers.
Back in my day I was taught that optimal monetary policy can get an ecomomy up to operating at its real capacity — but if that capacity is being kneecapped and throttled by the government, money policy can’t offset that. I don’t see how more NGDP growth is going to fix a good number of those kneecappings. So why is the CCP doing all these nasty things to throttle its own economy?
Kevin Rudd earned a PhD from Oxford on the subject of Xi Jinping after his time as Prime Minister of Australia and before becoming its Ambassador to the USA. That’s on top of all his personal experience with China. Here’s his thesis, and here he gives a long interview on the subject. Kevin Rudd: Understanding How China Sees the World. Watch the whole thing. He starts by saying this is *fundamental*…
He then gives Xi’s ten top priorities in order. #1 is “keep the CCP and Xi personally in power at all costs”, while “grow the economy” is only #3. He then discusses the great promise of China’s economic plans circa 2013 and deals with the question of what happened after 2017, “When they had a system that worked so well for so long, why change it?” His answer is…
What’s happening to China’s economy is Leninism 101 re-asserting itself. As to weak consumer demand – the financial repression of consumers to finance massive production – that’s not a bug of the system, it’s a *feature*. That’s why it never changes. Leninism’s religion is “material production” back to Marx himself. Stalin starved those millions of Ukrainians to sell their food to get money to build factory cities (full of severely exploited workers that produced vast amounts of mostly junk). That never changed. The USSR had cosmonauts in space before it had toilet paper. Xi cites Stalin as the model for the CCP to follow. A civilian population that becomes too well off also becomes harder to control, just like those too-successful entrepreneurs.
Understanding that the CCP is embracing Leninist economics, that politics needs are taking control of entrepreneurs, and economic growth now is only a third priority, nothing remains a mystery any more. Although many things may be more alarming.
What is a mystery to me is how on a Libertarian economics site – of all places – not even one person mentions that China has an overtly Leninist regime which, of course, affects its economic policies. Befuddling.
Warren Platts
Sep 28 2024 at 5:57pm
Outstanding post Jim!! However, the solution to the mystery is very simple, although I’ll doubt you’ll like it. Since Leninism is the diametrical antithesis of Libertarianism in every conceivable respect (even Mussolini didn’t go out of his way to kneecap Italian corporations!), then the dangling implication is that Libertarians should do what is practical to bring about the (hopefully peaceful) demise of the Leninist system. But that in turn would seem to entail things like trade interventions that are anathema to the identity of Libertarians. Michael Pettis himself has remarked on numerous occasions that if the U.S. were simply to end its trade deficit, that would throw a huge spanner into the CCP’s economic engine. (I’m honestly surprised they haven’t yet kicked him out of China..)
Jim Glass
Sep 30 2024 at 3:46pm
No exaggeration!
Japan didn’t have to deal with THIS either.