China’s Slump Hints At A Unique Liquidity Trap

China is awash with money, yet its growth is slowing.

China's situation might be what economists call a liquidity trap, though interpretations vary.

To avoid prolonged stagnation, President Xi Jinping’s administration may need to spend its way out of the problem. However, classic remedies may not be effective in Beijing’s “socialist market economy,” Chan Ka Sing wrote for Reuters Breakingviews.

China's situation might be what economists call a liquidity trap, though interpretations vary. During the Great Depression, John Maynard Keynes described a scenario where bond yields fall to a lower limit and individuals hoard cash.

In 1998, after Japan’s property bubble burst, its economy slid into recession, and monetary policy lost impact as interest rates were close to zero.

Paul Krugman warned that other countries could face similar problems. Variations of this crisis now threaten the world’s second-biggest economy. Chinese interest rates are far from zero; the benchmark one-year loan prime rate, for instance, is at 3.45% after Monday’s surprise cut.

State media have dismissed concerns about a liquidity trap. Krugman argued that monetary policy could be effective if central bankers “credibly promise to be irresponsible,” implying that forceful action could help if it ends entrenched expectations that economic conditions will worsen.

Some similarities between China today and Japan three decades ago are clear.

While most developed economies in the West are trying to tame stubborn inflation, changes in China’s consumer price index have hovered around zero since the beginning of 2023.

Like the Bank of Japan before it, the People’s Bank of China (PBOC) is loosening monetary policy, but prices refuse to respond.

The result is a record supply of money. China defines the metric known as M2 as cash in circulation, plus a set of deposits including time deposits to corporates and household savings.

From 1949 to 2013, this measure reached 100 trillion yuan, about $14 trillion at current exchange rates.

In the next decade or so until April this year, it surpassed 300 trillion yuan, now exceeding the broad money supply in the United States and Europe combined, according to data provider CEIC.

When measured against the size of GDP, the money supply in China is also the highest among major economies.