Money supply growth has important implications for the Chinese economy. If there’s too much money lying around, it can lead to inflation and speculative activities. If there’s too little, it can constrain financial health and economic activity. The important money supply groups are M1 and M2. M1 tracks the bills and coins in circulation as well as demand deposits, while M2 is M1 plus time, savings, and other deposits.
Easy money is no longer available
In November 2013, China’s M1 supply grew 9.40% from a year ago, up from October’s 8.90%. Supply for money, measured in M2, grew 14.2% in November—relatively unchanged from the 14.3% reported in October. From a long-term standpoint, China’s money supply growth has trailed the levels before 2011, another sign that the period of easy credit is no longer available. Yet money supply growth could be turning up, as you can see just by looking at the chart above.
Peaks and troughs
Investors might notice that peaks and troughs in M1 have coincided closely with China’s overall economic activity in the past, another sign that China’s economy was largely driven by loans and direction under a single government. But this doesn’t mean the next turn-up in money supply would definitely lead straight to a positive economy. Money supply growth can also rise from the central bank’s effort to alleviate tension, rather than create loans and demand. Both support demand, but investors would likely see slower economic growth or even economic collapse in the first case before things improved.
Consider that growth in money supply doesn’t necessarily create inflation (a topic we’ll discuss later). If the country is running below capacity, higher money supply won’t lead to higher prices. But if growth is on track and the economy is operating at solid levels, creation of more money sets the premise for higher inflation—if you have more money chasing after a limited number of goods, prices will rise. One way to see whether inflation is imminent is by comparing the growth in M1 and M2. Since M2 is M1 plus time, savings, and other deposits, M2 tends to grow faster when people think inflation expectation is low and more money is parked in interest-generating accounts.