Credit Suisse’s Dong Tao: China is in a liquidity trap8 June, 2012, 11:33. Posted by Zarathustra
The market is definitely not hugely impressed by the interest rates cuts yesterday (because of this chart?). While the consensus seems to have emerged that by allowing banks to set deposit rates 10% higher than benchmark is an important step towards interest rates liberalisation, interest rates liberalisation by itself has very little to do with economic growth in the short-term at this juncture. There is also a consensus that there is a rather big possibility that the data dump in the coming weekend will look really awful.
Here, while we have had no doubt about the willingness of the Chinese government to maintain growth, we have had serious doubt about the ability of the government to actually spur growth when necessary. Perhaps following paragraphs will not be the thing that bulls want to read the most.
China is in liquidity trap, just like everyone else in the world. That’s according to Dong Tao of Credit Suisse.
This is not a usual thing to be heard regarding to China. After all, the popular definition of liquidity trap is more or less that interest rates are already close to zero such that there is no way to be lowered, and there is indeed much room to cut interest rates across maturities. So it seems, at first glance, to be absurd to claim that China is in anywhere close to a liquidity trap (*).
But we did talk about debt deflation. We firmly believe that this is, if not already happening, will soon happen. In a debt deflation scenario, debtors will be rushing to pay down debt (or else they are defaulting), and the economy is not interested in taking on more debt. In that scenario, cutting interest rates alone will indeed have very little positive impact on lending. We are probably not quite near a liquidity trap, but sooner or later, we believe we will get there.
Dong Tao of Credit Suisse (one of the very few sell-side China economists that we actually care what they say) believe that China is in a liquidity trap:
However, we believe that a cut in the lending rate will only have limited impact in stimulating investment. We believe China is in a liquidity trap. With a low interest rate environment, further cuts in interest rates may not get much of an additional impact. Today’s problem in China is not about funding cost or bank liquidity, but demand for loans for real businesses. As companies in the real businesses struggle with surging costs, over-capacity, and weakened demand, the incentive to conduct real investments is low. It would take some structural changes to jump-start the momentum of investments in the private sector, instead of just through easing monetary policy.
(*) Of course this is probably not the meaning of liquidity trap in its original sense, and I am not going to get wonkish on that (if you do, however, read this).