Tuesday, December 29, 2009

Monetary Velocity and Growth in China

I want to amend my earlier China article by expanding on the monetary side of Chinese economics. Yes, China is becoming a closed economic system. However, even a slight uptick in urban spending, and hence monetary velocity, can go a long way in the monetary system. Any little bit of trickle-down to the rural areas will be significant from the rural perspective. So China still has plenty of space to grow before reaching the glass ceiling of a closed economic system.

However, it is difficult for China to manipulate the monetary velocity through the central bank, due to the shadow financing system in China. With interest rates being a limited tool, Chinese leaders depend on moral-suasion to boost the monetary system. To boost velocity, they have to encourage consumers to spend more and save less. An ill-timed bubble bursting will derail their campaign for a higher velocity, with consumers scrambling for cash to pay down informal obligations.

With the excess of industrial capacity, China does have room to print more currency. That is part of how they're financing the current infrastructure stimulus. This debasing of currency also helps the Yuan to keep up with the sliding Dollar.

It will be interesting to see if China reverses its currency policy and allows the export of the Yuan to other countries.

No comments: