Wang Yongli: Global Monetary Policies are in Urgent Need of Adjustment

2014-07-29 IMI

Wang Yongli: Former Vice President, Bank of China Since 2008, major economies have adopted unprecedented aggressive financial bailout plans or economic stimulus measures in order to cope with financial crisis and economic recession. Due to various reasons, each country’s macro economic policies share differences in how they are carried out and how aggressively they are adopted, and hence result in different effects. In addition, major economies’ monetary policies are increasingly differentiated. This invites thorough study and urgent discussion. The relation between monetary supply and central bank’s balance sheet The balance sheet expansions of main central banks are of different speed. At the end of 2013, the asset balance of China’s central bank is 1.88 times of that at the end of 2007, the time before global financial crisis broke out, United States 4.49 times, United Kingdom 5.18 times, European Central Bank 1.5 times (at the end of 2012, that is 1,96 times than the end of 2007), and Japan 2.01 times. The expansion of central banks in UK and US are among the fastest, which means their supplies of monetary base are much larger than the normal, giving people a sense that they are printing money at full capacity. The effect of central banks’ balance sheet expansion, however, is dependent on the changes of amount of money in circulation. During this time, major economies’ growth of M2(or M3) share huge differences, and surprisingly, the changes of money supply are not in accord with central banks’ speed of balance sheet expansion. Despite central banks’ scales of balance sheet expansion in UK and US are beyond normal, the amounts of money in circulation are not (the annual growth rate in US is within 7%, and in UK within 5%), which is in stark contrast with the picture that they are printing money at full capacity. The growths of money in circulation in Eurozone and Japan are quite low (with an annual growth rate of slightly over 2%), showing an obvious trend of deflation. In contrast, though Chinese central bank’s scale of expansion is much smaller than that of UK and US, the growth of money in circulation (with an annual growth rate of over 18%) is much higher than the two countries’, making China’s growth of money in circulation the fastest among main economies. Currently, the PBoC’s scale of balance sheet and China’s amount of money in circulation are the largest in the world. By the end of 2013, PBoC’s scale of balance sheet is 1.27 times of US, and the M2 money supply in China is 1,64 times of US. Nevertheless, China’s GDP (56.88 trillion yuan, or around 9.3 trillion dollars) is merely 55.5% of US GDP (16.8 trillion dollars). The M2/GDP of China in 2013 is 194.55%, while the number in US is only 65.85%. Since 2007, the growth of each country’s money supply has not been consistent with its central bank’s balance sheet expansion, and the growth trend has registered an obvious difference. This reflects a situation worth noting: after the breakout of global financial crisis, the deleveraging levels of different financial institutions and countries are different. The deleveraging process did not occur in Chinese financial institutions, and hence these institutions’ credit supply and money creation capability are not crippled. On the contrary, the leverage ratio of the entire society is on rapid rise. While in other countries, especially in the UK and US, financial institutions have undergone obvious deleveraging process, and a large quantity of capital is not used for lending (social demand for loans is also slack), but deposited in central banks. This results in severe deflation, and force central banks to cut deposit interest rates substantially (or even adopt negative interest rates) and expand their balance sheets to maintain a necessary level of money supply and liquidity. Since money-issuing channels have increased at one place and decreased at another, central banks’ large scale of balance sheet expansion has not resulted in the same scale of growth in M2 or M3 money supply. This shows that money issuing is not entirely performed by central banks, and is also largely, performed through commercial banks’ credit creation. Under such circumstances, the belief that central banks’ balance sheet expansion will certainly lead to the same scale of growth in money supply or even a multiplier effect is oversimplifying the situation. On the level of macro policy, the condition of social liquidity and interest rate level are the most important indicator of money supply, instead of the scale of central bank’s balance sheet expansion. In order to maintain the necessary liquidity and stability of financial system, the central bank is not supposed to pay too much attention to its own balance sheet changes and profit and loss statement. Special aspects of Chinese monetary policies According to structures of central banks’ balance sheets (available on each central bank’s website), there exist some distinct differences on the balance sheet of PBoC from other central banks. The largest difference is that PBoC’s largest asset has been foreign exchange reserve. The position for foreign exchange is 26.43 trillion yuan, and the reserve accounts for 83.3% of total assets by the end of 2013, up by 15.2 percentage points from the end of 2007. On the other side of the balance sheet, the largest liabilities of China’s central bank has been commercial banks’ required deposit reserve, which stands over 18 trillion yuan and accounts for around 56% of total liabilities by the end of 2013. (In order to hedge excessive buildup of position for foreign exchange and base currency, PBoC has largely raised reserve requirement. Through draining liquidity from the banking sector, banks are left less room to extend loans and create currency, and hence overgrowth of money supply can be reined.) The two items, however, stand low on balance sheets of other central banks, and little increase has been registered since the financial crisis. Since there exists some distinct differences between the balance sheet of PBoC and other central banks, monetary policies in China and other countries are carried out in different ways, and the changes of money supply in China and other countries differ. In respect of major economies’ money supply, while Chinese GDP is far smaller than the US, China’s money supply is way above the US. The reasons why China is the country with the largest money supply are complicated, but there are three aspects need not to be neglected: First, PBoC purchases foreign exchange on a large scale (because of very complicated reasons), and, correspondingly, expands the issuing of base currency. By the end of 2013, position for foreign exchange has reached 26.43 trillion yuan, which is an incomparable number by other central banks. Second, social financing in China is heavily dependent on indirect financing such as bank loans, and the proportion of direct financing is much lower than that in other major economies. Since direct financing and indirect financing have very different effects on credit creation and money issuing, with capital support of the same scale, the increase of social liabilities and money supply by indirect financing is faster. This is the reason why, since 2007, Chinese stock indexes have fallen sharply, capital market suffered severe recession, direct financing functions shrunk, most social financing been performed through bank loans, and social debt levels been pushed up (especially corporate debt ratio). These problems have caught an increasing number of people’s attention and concern. Third, social capital allocation is not market-oriented enough, and the decisive role of market is yet to be played fully. After the crisis, though other major economies such as the UK and the US have also adopted abnormally easy monetary policies, the focus of their policies is on the overall monetary expansion and reducing interest rates. At the same time, they have been avoiding direct allocation or intervening the flow of capital, and maintaining the decisive role of market in resources allocation. By contrast, during economic stimulus and targeted adjustment after the crisis, the extent of Chinese government’s direct investment and control over resources allocation is way larger than other major economies, which has constrained market competition and mechanism of survival of the fittest, and impeded the flow of capital and efficiency. Global economic growth is still weak Currently, financial operation and economic growth in the UK and US have been stabilized, and their nominal GDP growth rates are maintained above 3%. The situation differs in Eurozone and Japan, where deleveraging processes of financial institutions and the whole society are weaker, and there is a clear gap between their financial activities and economic growths and those of the UK and US. After 2009 when China adopted a massive stimulus plan, economic growth rallied and reached a high level, surpassing Japan and becoming the second largest economy in terms of GDP and an important engine of global growth. But afterwards, though its money supply growth has been maintain above 14%, its economic growth has showed clear signs of declining. This is worth noting. Since 2012, China’s growth rates are below 8%. China now is in the period of gear-changing, economic structure adjustment, and absorbing the effects of prior stimulus policies, and the overlapping of these three states have brought up multiple problems and challenges. It seems that without stimulus measures (or even continuous micro-stimulus), economic growth might dip further to a range of below 7%. The objective conditions, however, of another massive stimulus plan are not favorable any more (because the market potential of massive investment and returns have been largely reduced). Since the crisis, Chinese financial institutions and the whole society have been leveraging and this is not sustainable. Deleveraging process is unavoidable, or even the time to deleverage has already come. Once China is on the path of deleveraging, its growth will face the genuine challenge of “guarding against systemic and regional financial risks, and stabilizing growth”. As a matter of fact, China does not stand alone, and many other emerging economies feel the same pain. Since the crisis, large quantities of capital fled from developed countries to emerging economies, extending a heavy blow to their already heavily hit economies, but at the same time, galvanizing rapid development in emerging economies, which result in the famous “BRICS” countries. But since the emerging economies have been leveraging instead of deleveraging after the crisis, they would certainly face severe leverage risks under the circumstances of excess liquidity and over-capacity worldwide. After 2012, the UK and US have basically finished the deleveraging process. Their economies are rallying and recovering, and capital is flowing back. This change makes economies of the emerging markets including the BRICS declining, and some even face increasingly serious stagflation. Up until now, China faces relatively lighter pressure and fares relatively well. The global financial crisis and economic recession in 2008 prove that worldwide excess liquidity and over-capacity are very severe. After the crisis, the further injected liquidity and capacity by major economies might play an important role in fending off financial shock and economic recession, but at the same time might accumulated more risks. After 30 years of globalization, excess liquidity and over-capacity have developed to an extreme extent, and the constraint of insufficient demand is becoming more severe. Currently, the uneven recovery and overall downturn make it difficult for the world economy to recover to prior-crisis conditions rapidly. Though in terms of nominal GDP, world economy is picking up. However, at constant prices, global growth is still sluggish. According to Consensus Economics, the real GDP growth of UK could register 3%, the US 2.2%, Germany 2%, Japan 1.5%, and Eurozone 1.1%. Emerging economies would face greater challenges. The big picture here is not rosy yet. The situation of uneven recovery and overall downturn would exist for a long period, which might trigger each country to increase the strength of stimulus, and make the marginal returns of these policies diminish, making the negative externalities more severe. We must stay on high alert to this. Clearly divergent direction of each country’s monetary policy It seems that there exist a clear relevance between changes of GDP and M2 money supply, and that this has justified the stimulus effect on economy of expanding money supply. However, the case of Japan is worth ruminating: its nominal GDP shrunk, instead of increased, when money supply expanded. The further question is, why, after six years of the crisis, the recovery of world economy is still uneven, and the overall downturn lingers? Is it normal because the effects of monetary expansion lag behind, or the scale of the expansion is still insufficient? Or because the stimulus effects of monetary expansion are limited when world over-capacity and excess liquidity are severe and total demand is obviously insufficient, and hence monetary expansion alone is not enough to drive economic growth? After the breakout of the crisis, major economies adopted long-term aggressively expansionary monetary and fiscal policies to further expand money supply and build up capacity. Even though it is fending off short-term financial shocks and economic recession, would this accumulate risks that are even more serious and trigger more severe global financial and economic crises? What side effects might be brought up by monetary expansion? How should the appropriate money supply be measured? These questions need to be thoroughly studied. According to the changes of major central banks’ balance sheets and money supplies since 2007, large differentiations are registered, and different countries’ monetary policies are clearly divergent. This results in large scales of international flows of funds and arbitrages, and exacerbates financial turmoil. Therefore, how to enhance coordination among monetary policies of major economies has become an important global economic and financial topic. In times of economic globalization, especially when flow of capital is highly globalized, each country’s monetary policy is rather independent, and each monetary authority adopts policies that are most favorable for itself. This might trigger competitive easy money policies, distorting market prices and economic activities. This situation might also separate capital from real economy and confine capital within financial sector, attract more profits from real economy to financial sector, invite speculation, restrain recovery, intensify conflicts, and make easy monetary policies easy to adopt but hard to exit. This situation is inconsistent with globalization, and hence enhancing global monetary policy coordination is urgently needed and reforms of international monetary and financial system should be promoted at earliest time possible. Currently, special attention should also be paid to situation of Chinese financial and economic development. Since the crisis, China’s economic and financial development has made a great contribution to world economic and financial stability. As the second largest economy, China’s economic and financial development exerts great influences over global economy and finance. However, increasing problems emerging in China’s financial sector demonstrate that investment driven and debt-driven economy is not sustainable. China urgently needs transformation of economic structure. It is fairly to say that the challenge resulting from deleveraging has just arrived, and China’s economy and financial sector will face even more fierce challenge. Because of this, not only China should be on high alert and prepare for the worst scenario, other major economies should also pay close attention to China’s future economic goals and macro policies and how China is making early plan and preparing financial reforms and development (including contingency plan). We are supposed to promote international communication on macro policies and experience sharing, and confront the coming challenges jointly.

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Wang Yongli: Global Monetary Policies are in Urgent Need of Adjustment

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