China’s proposal of a 300 billion Yuan bank loan to rescue the housing sector may seem like a small amount compared to the outstanding debt, but there are reasons behind this decision. Unlike other countries that would rely on the central bank to inject liquidity and print money, China has taken a different approach. This could be due to internal conflicts within the regime. The billionaires in China pose a potential threat to the existing dictatorship, and by creating a housing crisis, their wealth would be significantly reduced, diminishing their influence.
Another reason for inaction could be the fear of a sharper cliff fall. While policy inaction may lead to a faster resolution of the crisis, there is a high risk of things spiraling out of control once a crisis is unleashed. This is a realization that China seems to have reached.
Additionally, China is wary of the consequences of excessive money creation. History has shown that when the country experimented with massive money printing in the 1940s, hyperinflation ensued, leading to the collapse of the currency and ultimately, the political regime. The ruling regime in China is well aware of this history and would rather endure a prolonged economic depression than risk the collapse of their political power.
But how likely is it for China to experience hyperinflation or a currency collapse despite engaging in large-scale money creation? Other countries like the U.S. and Japan have engaged in similar practices without facing such dire consequences. However, China’s size and unique circumstances make it uncertain whether they would be immune to these risks. In 2009, when China experimented with money creation on a large scale, inflation did reach over 6 percent after two years. This shows that the threat of inflation is real even for a country as big as China.
Interestingly, in recent years, China has seen the opposite effect. Despite two rounds of monetary expansion since 2018, with M2 year-over-year growth reaching double digits, the impact has been deflation rather than inflation. This has been accompanied by currency depreciation. The chart comparing China-US M2 year-over-year growth gap with the USD and CNY reveals that as China’s M2 growth exceeded that of the U.S., depreciation followed after about a year. This demonstrates that excess money creation poses a threat to the value of the currency, as seen in recent experiments.
Given these circumstances, China’s only option may be to gradually print excess money and allow the currency to depreciate slowly, even if it means enduring a severe recession and a series of defaults. There is always the possibility that they may resort to sharp currency devaluation, but the uncertainty surrounding such a move is high.
In conclusion, China’s approach to the housing crisis and its reluctance to rely on the central bank for liquidity injections can be attributed to internal power struggles, the fear of an uncontrollable crisis, and the historical lessons learned from excessive money creation. While there are risks involved, China seems to be navigating through these challenges, albeit with caution and a long-term perspective in mind.
