Over the past quarter-century, China has engineered the largest monetary expansion in human history. China’s M2 money-supply was RMB5.8 trillion ($ 0.67 trillion) in January 1996. By August 2008, China’s M2 had soared nearly 10-fold to $ 6.56 trillion, and it has since expanded further to US$ 30.2 trillion by June 2020 – – far larger than the next-largest national stock of M2 (the US pile, now merely US$ 18.36 trillion). China’s M2 has thus risen 45-fold over the past 24 years. In June 2003, China’s banking system was bust, with NPLs of 50% (according to an S&P report, which had to be withdrawn under pressure from China’s government). China removed 45% of all its banks’ loans from their books at face value between 2003 and 2006, thereby exacerbating moral hazard. Premier Wen Jiabao tried reining-in credit in 2007, but the spigot of bank lending was reopened with the GFC in 4Q 2008.
China has defied the monetarist prediction that rapid monetary expansion would trigger inflation. Instead, monetary expansion has mainly fueled investment spending in China, and the expanded capacity has depressed prices – first within China, then across the world. China has accounted for more than half of global output of steel, aluminum and cement for each of the past 5 years – and most of the annual increase in global steel and aluminum output occurs in China. Cars, chemicals, cement, solar panels, telecom equipment are other sectors where China’s relentless capacity-expansion crowds out other producers. (In steel, no other country has ever produced more than 128 million tonnes in a year; China surpassed that mark 20 years ago, and its output reached 996 million tonnes in 2019; the rest of the world’s steel output increased just 2% between 2007 and 2019). We estimate that, while China’s fixed investment spending in 2016 was 16-times what it was in 1996, fixed investment spending in the OECD increased merely 50% over those 20 years. The global investment drought (emblem of “secular stagnation”) is mainly caused by China.
China, a non-market economy that does not respond to normal market signals, is massively distorting the world economy – but also distorting Macroeconomic theory, which fails to incorporate the impact of the world’s largest manufacturer and exporter. The persistence of low inflation globally despite surging money-creation is fundamentally a phenomenon that can be laid at China’s door.
The key medium-term implication for markets is that – with the world refusing to participate in China’s state-capitalist capacity-expansion – China will struggle to export its overcapacity once the rest of the world’s economies reopen by 4Q 2020. Given that only small quantities of cement can be shipped by sea, China has been obliged to cut its cement capacity in the past 4 years, but its steel and aluminum output have continued to expand even this year (as they did in 2009 and 1998 amid global / Asian recessions). As more barriers to China’s dumping of steel, aluminum, 5G telecom equipment, solar panels, etc. emerge, China will face a slow-burning financial crisis – exacerbated by rising vacancy rates of residential and commercial real-estate across its cities. Amid a liquidity-driven equity rally, we recommend staying well clear of China’s banks and limit exposure to the rest of China’s equity market (other than its technology sector).