China is at mounting risk of a Japanese-style "liquidity trap" as monetary policy loses traction and the economy approaches credit exhaustion, forcing a shift towards Keynesian fiscal stimulus.

Officials at the Chinese People’s Bank (PBOC) have begun to call for a fundamental change in strategy, warning that interest rate cuts have become an increasingly blunt tool.

They cannot easily stop companies hoarding cash or halt the slide in private investment.

Sheng Songcheng, the PBOC’s head of analysis, set off a storm last month by warning that the economy had “started to show some signs of being caught in a liquidity trap”.

He has since stepped up his pleas for action by the fiscal authorities to relieve the burden on the central bank, a Chinese variant of the parallel drama that is being played out in Europe and Japan.

Mr Sheng told China Business News on Monday that the country has a very low reliance on foreign borrowing and can easily afford to shore up the economy with a Keynesian boost.

“China can let its deficit-to-GDP ratio rise to over 3pc or even 5pc in the long run. It can spur growth more effectively by lowering corporate taxes than by cutting the interest rate,” he said.

The powerful State Council has now joined the chorus with calls this week for a $75bn cut in business taxes to boost confidence and channel stimulus to the productive economy.

And:

Simon Ward, a monetary expert from Henderson Global Investors, said there is nothing to fear. The surge in M1 is a sign that companies and consumers are shifting money into their accounts in order to spend it, and this will cause economic growth to pick up yet further over coming months.

Mr Ward said the ‘velocity’ of M2 money is almost certainly accelerating. “It is the opposite of a liquidity trap,” he said.

David Fuller's view

I would be very surprised if China was at increasing risk of a Japanese-style liquidity trap, as mentioned in the opening sentence above.  Some financial commentators are understandably spooked by widespread deflation but that is a far greater problem for developed than developing economies. 

We know that China’s PBOC now has an aggressively accommodative monetary policy.  This is reflected by a number of the charts, staring with the Shanghai Composite Index.  This shows base formation characteristics above earlier large base which supported the surging advance between July 2014 and June 2015, which the government reigned in to prevent overheating.  The current pattern is ranging higher and a close beneath 2.900 would be required to question short to medium-term upward scope.  Hong Kong’s China Enterprises (H-Shares) Index shows a similar pattern, albeit from a lower level relative to the earlier trading.  It is currently consolidating gains but a close beneath 9000 would be required to question medium-term upward potential.  Lastly, the Hong Kong Hang Seng Index is temporarily overextended near its October 2015 high but a consolidation above the MA would not negate medium-term recovery prospects. 

Here is a PDF of AE-P’s article.