World is closer to deflationary depression

What has changed is that there is far less pretense that everything is 'normal' than before. There are more articles of this sort coming through. Of course the day that the print media in New Zealand starts to acknowledge reality will be when you truly know it is time to take your money out of the bank and prepare for the worst (presuming you haven't done so already)

World edges closer to deflationary slump as money contracts in China

All key indicators of China's money supply are flashing warning signs. The broader measures have slumped to stagnation levels not seen since the late 1990s.

By Ambrose Evans-Pritchard, International business editor

The Telegraph,

15 May, 2012

Narrow M1 data for April is the weakest since modern records began. Real M1 deposits – a leading indicator of economic growth six months or so ahead – have contracted since November.

They are shrinking faster that at any time during the 2008-2009 crisis, and faster than in Spain right now, according to Simon Ward at Henderson Global Investors.

If China were a normal country, it would be hurtling into a brick wall. A "hard-landing" later this year would already be baked into the pie.

Whether this hybrid system of market Leninism – with banks run by Party bosses – conforms to Western monetary theory is a hotly contested point.

The issue will be settled one way or the other soon.

What seems clear is that China's economy did not bottom out as expected in the first quarter. It is flirting with real trouble. Yao Wei from Societe Generale says a blizzard of awful data "screams out for easing".

China's electricity output – watched religiously by bears – slumped in April. It is up just 0.7pc over the last year. State investment in railways has fallen 44pc, with an accelerating downward lurch over recent months. Highway construction has dropped 2.7pc. "The data shows extreme weakness in the Chinese economy," said Alistair Thornton from IHS Global Insight in Beijing.

The Yangtze shipyards tell the tale. Caixin magazine said eight of the 10 largest builders in the country have not received a single new order this year. "A wave of closures in the shipbuilding industry has yet to begin. A hurricane is approaching," said one official.

Housing sales slumped 25pc in the first quarter, testimony to the zeal of regulators. This has since fed into a drastic fall in new building. Mr Thornton said floor place under construction fell 28.3pc in April.

This is hardly a sideshow. The sector employs 10pc of the Chinese work-force, and a further 20pc indirectly. Land sales provide 70pc of tax revenue to local authorities and 30pc to the central government. It is the "fair weather" financing illusion, as we saw in Ireland. China's scope for fiscal stimulus may be constrained if property goes into a long slump.

The property correction is deemed benign because it is planned. Premier Wen Jiabao wishes to forces down prices as a social welfare policy. Yet did the Fed not slam on the brakes in 1928 to choke an asset boom? Did the Bank of Japan not do likewise in 1990, only to find that boom-bust deflation has its own fiendish momentum? Once you let credit rise by 100pc of GDP in five years – as China has, more than in those US or Japanese episodes – you are at the mercy of powerful forces.

Something odd is now happening. The People's Bank said new loans fell from $160bn (£99.5bn) in March to $108bn in April. Non-conventional lending seized up altogether. Trust lending fell by 96pc, bankers' acceptance bills by 90pc. This is astonishing data.

It may not be as easy for Beijing to turn the tap back on again. Loan demand has been falling for months. Banks are offering credit. Companies are refusing to take it. This is the old Japanese story of pushing on a string, or the European story today.

"China is in deflation," says Charles Dumas from Lombard Street Research. Yes, consumer price inflation is 3.4pc – though falling – but consumption is a third of GDP. Fixed investment is 46pc, and here prices have dropped 3.5pc in six months. Export prices have dropped 6.6pc.

The authorities have belatedly responded, cutting the reserve ratio by 50 points to 20pc over the weekend. It is thin gruel. Are we to conclude that the People's Bank is bent on breaking excess capacity in a cathartic Schumpeterian purge, or that leadership battles have paralysed the Party? Hard to tell.

All the BRICs need watching. India's industrial output fell 3.5pc in March. The country seems caught in a 1970s stagflation vice. Brazil has softened too, with car sales down 15pc and industrial production contracting in March. The bad loans of the banks have reached 10.3pc, higher than post-Lehman.

The bubble has probably popped already, but hoteliers in Rio are hanging on.

The European Parliament has pulled out of the UN's Rio forum on sustainable development in June because the rooms are exorbitant. "We are short the vastly over-vaunted and over-owned BRICs," says hedge fund contrarian Hugh Hendry.

My fear has always been that the credit cycle in the Rising World would blow itself out before the Old World has safely recovered, or reached "escape velocity" to use the term in vogue.

Europe will slide further into 1930s self-destruction until it equips itself with a lender of last resort and takes all risk of EMU sovereign default off the table, though that may come too late. The US has functioning institutions at least but growth is barely above stall speed. Ben Bernanke's "massive fiscal cliff" looms this autumn. The Economic Cycle Research Institute (ECRI) has not yet withdrawn its US recession call.

The BRICS helped save us in 2008-2009. If we now face a global crisis on all fronts – and such an outcome can still be avoided – it will test the mettle of world leaders. Interest rates in the G10 are mostly zero already, and budgets are frighteningly stretched.

Sensing what is coming, Citigroup's chief economist Willem Buiter says global central banks have not yet exhausted their arsenal. They can "and should" crank up quantitative easing (QE), buy everything under the sun, and do "helicopter money drops".

I would go even further. sovereign central banks have the means to defeat any depression thrown at them by launching mass purchases of assets outside the banking system, working through the classic Hawtrey-Cassel quantity of money mechanism until nominal GDP is restored to its trend line.

The problem is not scientific. A world slump is preventable if leaders act with enough panache. The hindrance is that the Euro Tower still haunted by Hayekians, and most G10 citizens – and Telegraph readers from my painful experience – view such notions as Weimar debauchery, or plain Devil worship. Economists cannot command a democratic consent for monetary stimulus any more easily today than in 1932.

One can only pray that helicopter drops do not become necessary in the chilly winter of 2012-2013.