China QE and deflation: what are the implications?

Over the last 9-12 months China’s real estate debt crisis has caused generalized asset price declines, a substantial rise in non-performing loans and a rise of Total Debt/GDP above 300%. The CPI turned into deflationary territory in March 2023, and it printed -2% year over year last December. Although the authorities have taken several aggressive policy measures and prices appeared to have become more stable of late (-0.6% 6m saar) it is still early to determine if fiscal and monetary policy are being successful. The recent $500bn balance sheet expansion by PBOC may be a sign of things to come.

In a global macro context, these measures have a few interesting implications.

1)?Quantitative Easing. Since August 2023, PBOC has aggressively increased its balance sheet from RMB 42.7 tr. to RMB 45.7 tr. or by as much as $500 bn.

2)?Capital Account and the Renminbi. It is difficult to gauge how much of this QE makes its way outside of China’s closed capital account, but there are signs that part of it does. For example, there is positive correlation between the changes in China’s US Treasury holdings and the changes in the Renminbi exchange rate. This may indicate unsterilized intervention or simply a change in the composition of International Reserves, which have otherwise stayed around $3 tr. for the better part of 2023. China, depending on the estimates, runs a 2-4% current account surplus,? (https://www.cfr.org/blog/chinas-current-account-surplus-likely-much-bigger-reported), which implies a Financial Account deficit of up to $700bn a year. Not a sustainable balance.

3) China Deficit and debt dynamics. The IMF Article IV estimates a 2024 Government Budget Deficit of 7.4% of GDP and an augmented Deficit of 13.4%. Total Debt/GDP has risen to 300%, meaning that China cannot afford a slowdown nor deflation. Hence, notwithstanding several macro-economic measures enacted to stimulate consumption and strengthen credit and the banking system, a weaker exchange rate may become one more expansionary tool, particularly as the highly competitive Japanese Yen tests 37-year lows above 150.

4) US Treasuries. As outlined in a prior note those calling for a global de-dollarization in the context of a new world order, fail to understand the conditions for well-functioning capital markets. The reality is that foreign central banks continue to be net buyers of US Treasuries. Since December 2022 (according to TIC data), foreign official holdings of T-bills, Notes and Bonds have risen $120 billion (from $3,667 trillion to $3787.8 trillion). Interestingly, China’s official holdings have risen $47 bn. from October to December 2023.

5) Chinese and global equity markets. There appears to have been limited but not insignificant spillover of PBOC balance sheet expansion outside of China. Chances are that easier monetary policy (via RRR, interest rate cuts and PBOC balance sheet expansion), combined with several macro prudential policy measures and substantial fiscal expansion, will ultimately put a floor to local equities and reflate nominal GDP. One important indicator is the 6% increase in the TSF (Total Social Financing) which reached an annual RMB 12.7tr. in December ($ 1.7tr.). ?Japan did just that over the last 4 years. BOJ expanded its balance sheet by 30% and the Japanese yen has fallen by 28%. During the same period the Nikkei rallied 123%.

The King is dead, Long live the King!

Ruggero De Rossi (*) (**)

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(*) The analysis carried out and the views expressed in this note are personal and do not reflect in any way the official ones of the U.S. Department of The Treasury.

(**) Sources: PBOC, National Bureau of Statistics of China, Department of the US Treasury, BOJ, IMF, FRED, Bloomberg.

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