Recent better Chinese economic data, and an associated rebound in China investment plays, were signalled by a pick-up in monetary growth in the second half of 2015. Pessimists, however, argue that economic recovery is based on unsustainable policies and will fizzle in the second half of 2016. Monetary trends have cooled since the start of 2016 but would need to weaken significantly further to support the pessimistic case.

The first chart shows six-month growth rates of industrial output and narrow money deflated by consumer prices. The narrow money measure used is “true” M1, comprising currency in circulation and demand / temporary deposits of households and non-financial enterprises. This is superior conceptually and in terms of historical forecasting performance to the official M1 measure, which excludes household deposits. Such deposits, clearly, are relevant for assessing consumer spending prospects.


Real narrow money contracted in late 2014, warning of economic weakness in 2015. Growth resumed early last year and surged from the summer. It peaked in January 2016, falling back in March to its lowest since August.

This turnaround is confirmed by broader aggregates. The preferred broad measure here is M2 excluding financial deposits, which are less likely to have signalling value about economic prospects. Such deposits grew strongly in 2014-15, inflating the headline M2 measure, but have slowed recently. Six-month growth of real M2 excluding financial deposits also fell notably in February / March – second chart.


The reversal in real money growth follows a period of significant strength and is judged here to be insufficient in terms of magnitude and duration to warrant shifting back to a negative view of economic prospects.

Monetary trends typically lead economic activity by about nine months. Even if the January real money growth peak is confirmed, the suggestion is that economic momentum will continue to rise into October 2016.

The March level of six-month real narrow money growth, moreover, remains robust by historical standards, at more than 7%, or 15% at an annualised rate. The slowdown to date, in other words, is consistent with a moderation of economic expansion, not weakness.

A further point is that the fall in real narrow and broad money growth partly reflects a sharp rise in six-month consumer price inflation, due to stronger food prices. A recovery, therefore, is possible as the food price effect fades or reverses.

Finally, pessimists may be neglecting additional economic stimulus from recent exchange rate depreciation. The China Foreign Exchange Trade System (CFETS) RMB index against a basket of trade-partner currencies has fallen by 8% from a peak in August 2015, equivalent to an annualised rate of decline of 11% – third chart. The pessimists, ironically, were correct to expect the authorities to engineer a weaker currency but underestimated their ability to achieve this, with the Fed’s help, without negative financial / economic consequences.