In 1939, Sir Winston Churchill said that Russia was “… a riddle wrapped in a mystery inside an enigma”. The same could be said of China today.

In many respects China is a land of contradictions, led by its curious blend of communism and capitalism; the latest money and credit supply figures highlight the point. On the one hand, we see a measure of money supply growing at an all-time low rate, whilst another measure of credit continues to give mixed messages.

The money supply measure, M2, comprises currency in circulation plus demand, time and savings deposits with the Peoples Bank of China and banking institutions. Having surged in 2009 to an inflation rate of almost 30% per-annum, M2 has been dis-inflating since then. The latest readings, released in June, show a rate of 9.60%, an all-time low for the series. Within the numbers, Chinese Yuan deposits showed the largest drop in growth rate. The Peoples Bank of China said that the drop in M2 growth was in part due to

“…intensified supervision that has compelled the financial system to reduce leverage.”

And that,

”…slower M2 growth than in the past will become a new normal”.

They may want to be careful what they wish for because, although they think they can control the money supply, when a deflationary mood sets in with the general population, authorities are quite powerless to change that.

However, the broad measure of credit known in China as Total Social Finance, although showing a decline in growth rate, is still worryingly high. Total Social Finance was introduced as a way to estimate total credit in the Chinese economy and the effect of the vast shadow-banking system. It includes off-balance sheet forms of financing that exist outside the conventional bank lending system, such as initial public offerings, loans from trust companies and bond sales. Aggregate financing rose CNY1.06tr (USD 156b) in May, down from the CNY1.39tr added in April and the CNY2.14tr added in March.

So, evidence of a slowdown in this measurement of credit growth may be coming through in China. It would certainly be incredible to see it accelerating at the same pace it has done in recent years as the chart below, of Total Social Finance as a percent of Gross Domestic Product (GDP) shows.

High levels of debt to GDP can be sustained for a while but a country cannot keep adding more and more debt (especially unproductive debt) ad infinitum. The World Bank has a measurement of countries’ Domestic Credit to the Private Sector and the fifth highest on that list is Thailand at 147% of GDP, then China, third highest is Switzerland and second is the USA at 193%. Topping the World Bank list though is Cyprus at 230% private sector debt to GDP; actually contracting from a high of 254% in 2013. When it was at 180% in 2007 the Cypriot stock market was at its zenith. Since then, the share index has shed 98% of its value.

With Total Social Finance (credit) in China at 216% of GDP, there is substantial scope for a contraction of debt in the economy. That, combined with the dis-inflating money supply, would start to make deflationists excited.

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