When Marco Polo went to China he discovered something better than alchemy. Rather than turning base metals into gold, he marvelled that the Chinese were creating money out of paper. But what the 13thcentury Venetian traveller could not know was how perilous a paper currency would prove for the country that invented it.
At intervals in their history, Chinese rulers have succumbed to the temptation to pay off spiralling debts simply by rolling the money printing presses. Inflationary scourges ravaged dynasty after dynasty, with both the
Mongols and Mao Zedong’s Communists seizing power in a country eviscerated by depreciated paper.
Such episodes sound uncomfortable echoes for Beijing as it wrestles to control its latest bout of monetary exuberance. The current tussle to ward off a financial crisis pits the world’s most powerful authoritarian system against the propensity of money to resist control as it seeps and flows like water through unattended apertures.
China’s problem this time is not inflation, at least not yet. It is rather that Beijing has again sent its printing presses into overdrive, creating what is almost certainly the biggest pool of domestic liquidity in history to help stimulate its economy and finance a crushing debt burden. The danger is that if the renminbi loses value internally or gushes out of China, a wave of unpaid debts could precipitate a crisis.
The dimensions of China’s liquidity splurge are startling. Ousmène Jacques Mandeng, formerly with the International Monetary Fund, has calculated that between 2007 and 2015 China created 63 per cent, or $16.1tn, of the growth in the world’s supply of money.
China now has more money coursing through the arteries of its economy than the eurozone and Japan combined — and almost as much as the US and the eurozone combined. Since the financial crisis, commentators have focused on the efforts of US, European and Japanese central banks to print money through “quantitative easing”, but China’s output has eclipsed them all.
Marco Polo would have been impressed. He noted with awe China’s capacity to print off as much money as it needed: “It may certainly be affirmed that the grand khan has a more extensive command of treasure than any other sovereign in the universe”.
But for China’s modern rulers, the effusion of liquidity presents as many problems as it promises to resolve. The main issue is that debts are piling up almost as fast as China generates money to service them, creating what Jonathan Anderson of the Emerging Advisors Group calls a “debt funding bubble”.
In his analysis, China’s crunch point will come when there is a disruption in the supply of money needed to pay total debts that amount to about 250 per cent of China’s gross domestic product, the highest level among any large emerging market.
Mr Anderson sees peril mainly in the form of a “madcap proliferation” of flaky financial institutions that lend out money they have raised by issuing debt. The potential for something to go wrong is considerable among a “chaotic hodgepodge of banks and non banks” that are fuelling China’s credit boom.
Officials also see another source of vulnerability. They fear that Chinese corporations and citizens will decide en masse that they would be better off taking their money abroad to buy companies or invest in gold, stocks or real estate. Such capital flight could sap the liquidity that is required to keep China’s bubble from popping.
These concerns explain Beijing’s plans to restrict outbound foreign investment. People familiar with the plans told the Financial Times that China intends to scrutinise acquisitions of overseas companies costing more than $1bn if they are outside the investors’ core business scope. Meanwhile, stateowned enterprises will not be allowed to invest more than $1bn on a single real estate transaction abroad. Gold purchases are also being curbed.
With outbound investments from Chinese corporations running at $150bn in the first 10 months of this year, up from $121bn last year, such outflows are increasingly being seen as part of a complex of problems that have also driven down China’s stockpile of foreign exchange reserves from almost $4tn in early 2014 to $3.12tn in October.
Outflows of even as much as $1tn may not seem too debilitating when set against China’s proven capacity to generate plentiful supplies of money. But the fact that Beijing is taking action reveals the knifeedge upon which Chinese policymakers are balancing.
So engorged with easy money have they become that Chinese banks are on average four times larger today than they were just eight years ago. But riskier still is the fact that several of its midsized banks rely for funding on socalled wholesale operations — a euphemism for issuing debt to relend.
The folly inherent in such a form of alchemy has been understood for at least 800 years. Ye Shi, a Song dynasty adviser, warned that issuing “kongqian” — or “empty money” that is not backed by assets — would stoke inflation and reduce people’s incomes. His emperor did not listen, triggering economic chaos that enfeebled China before the Mongol invasion.
Marco Polo noted with awe Chinese rulers’ capacity to print off as much cash as they needed