In short, the People's Bank of China seems to be tightening the reins on the money supply, which could lead to continued slowing in the Chinese economy.
Last Thursday, Bloomberg reported that the People's Bank of China sold $16 billion worth of short term debt to banks to select financial institutions as a way of draining excess liquidity. Central bank jargon calls these "repurchase agreements" but what it basically means is the PBOC is giving debt contracts to banks, and the banks give the PBOC money in return, which is then taken out of the circulating money supply. This shrinks the money supply overall.
Some Chinese analysts are insisting that this is not a change in overall policy, but rather the choice of local banks who don't want extra liquidity just sitting there due to low demand for loans, and would rather hold short term debt. But in the end, to execute these repurchases is ultimately the choice of the PBOC, so whatever policy it wants to project to the markets, China's central bank is making it clear that it is not averse to shrinking the money supply on request from its member banks to do so.
At the same time, the PBOC has cut its benchmark interest rate three times in six months to 5.1%, along with two cuts in reserve ratios. While these measures do loosen monetary policy, they do not increase money supply directly. They only enable Chinese member banks to increase money supply by increased lending. If lending does not increase, neither does the money supply, no matter how low benchmark interest rates or reserve ratios are.
But swinging back to tighter monetary policy measures, according to a Financial Times report published back in February citing this official PBOC report for the second half of 2014, the central bank's foreign assets fell by 155 billion renminbi ($25 billion), compared to a 1.5 trillion renminbi increase for the second half of 2013. Meaning, the PBOC sold foreign assets on net, and when it does that, it buys renminbi, absorbing it and directly shrinking the money supply. That drop continues even now.
While the monetary base (different from the money supply) increased by 2 trillion RMB due to a combination of open market operations and "other forms of lending by the PBOC to commercial banks", the official report does not tell us how much of that 2 trillion was open market operations and how much was increased lending to commercial banks. That matters because while open market operations directly increase the money supply (think quantitative easing), increased lending to commercial banks only makes it easier for the commercial banks to lend out, and only thereby increase the money supply. If they don't lend it out, nothing happens.
And judging by the chart below of loan growth, not much is happening right now.
In the end, the Financial Times admits that the new policy may just be a way of keeping things steady for now monetarily. With the PBOC draining money in some ways and pumping money in others, that indeed may be the most logical conclusion: "The consequence of the shift from inflow to outflow is that liquidity injections that were once taken as a sign of easing now appear more akin to efforts to maintain the status quo."
But, as Austrian Business Cycle Theory suggests, there need not be any actual shrinking in the money supply to bring on the bust after the boom. All that needs to happen is that the rate of increase slows. And if the policy of the People's Bank of China is indeed to maintain the status quo in the money supply, then we may have seen our top in the Chinese stock market, and its corresponding ETF, the iShares FTSE/Xinhua China 25 Index (FXI) - Get Report, just from last month.
I have called a top in Chinese stocks successfully before, though specifically in the Macau gaming sector. This time, unless the PBOC takes a hard turn towards aggressive expansion, the rest of the Chinese stock market may follow. Any Greek default in the coming weeks will certainly help things along in that direction.
This article is commentary by an independent contributor. At the time of publication, the author was short FXI.