When growth stops being growth, or the same growth, what do you do? The Keynesian textbooks all say “stimulus”, but what happens if the stimulus doesn’t stimulate? Worse, when it doesn’t stimulate because it can’t due to other pre-existing and intractable impediments.

This is Xi Jinping’s dilemma and it only begins with the textbook’s missing chapters on eurodollar money.

So, let’s start there and work backward to the Communist Catch-22. China’s system is dollarized, which in very simple terms means its internal monetary regime (RMB) is largely governed by this eurodollar externality. Briefly, the more the eurodollar produces “dollars” globally, the more tend to end up in places like China, the more get captured by its central bank and other authorities in the form of “foreign exchange” reserves.

These then underpin domestic RMB expansion; greater foreign exchange the larger the PBOC’s balance sheet therefore, absent any absorptions and domestic additions, what’s leftover on the liability side is more currency in the form of bank reserves as well as literal currency.

Thus, we can tie all these things together: external dollar shortage, diminishing foreign exchange growth if not contraction, therefore fewer RMB bank reserves along with smaller increases in physical currency. Here it is:


We’re going to focus here on Chinese bank reserves for reasons that will become apparent in a second. Slower dollar inflows, meaning global dollar shortage, lesser rate of increase (before 2014; no growth or bouts of outright contraction thereafter) PBOC foreign exchange leaves no balance sheet room for bank reserves (adjusting for RMB-only programs like the MLF which have been largely limited in scale to 2016-17).

The ups and downs for bank reserves match very well the ups and downs in eurodollars (corroborated by everything from the behavior of UST yields and yield curve to the dollar’s exchange value and TIC). This is both an immediate as well as longer-term problem because, shown above, bank reserves in China have been shrinking again (below is the 2-year change which shows that reserve growth has been limited beyond just the last two months of last year; the 2-year change matches eurodollar cycles even more closely).



Yet, as Ben Bernanke of all people had noticed thirty-five years ago when writing about the United States’ experience during the Great Depression, we have to consider more than direct monetary effects. These are often amplified by banking, and that’s where and how the real downside exists.

In other words, monetary tightness contributes to constrictions in the credit channel, too; especially the private credit channel. This means, in Communist China, the non-financial sector including both private and state-owned business but excluding (for now) the debt of general government entities.

Banks in China extend most of the credit and fund, at the margins, on the use and availability of bank reserves (thus, why our focus here on them).

For credit data I’m going to use BIS rather than PBOC figures because the former provides more comprehensive breakdowns by sector and obligor as we’ll need.



Starting 2014, both CNY and the growth rate of overall non-financial credit have largely declined. Beginning in 2016, Li Keqiang’s planned “rescue” using the Keynesian textbook (which included fiscal as well as monetary, as noted above with RMB expansion on the PBOC’s asset side) increased the level and pace of general government debt but did not lead to a commensurate or really any response in the form of non-financial credit.

That slowed regardless, and continues to this day.

China’s governments have been out there borrowing practically by themselves for over half a decade. While Keynes might’ve been pleased, Xi, obviously, was not (see: 2017’s 19th Party Congress).

The chart above actually understates the Chinese problem as it relates to the inability of the economy to recover due to these constant external money pressures. Again, dollar problem becomes RMB reserve/liquidity problem becomes credit problem (note: chart below uses a log scale for each series):

To offset the contraction in bank reserves since 2014, the PBOC has employed a variety of methods, none of which have fared to success. From reducing the RRR numerous times to lowering benchmark borrowing rates such as the LPR, whatever authorities come up with it doesn’t begin to offset the underlying negative forces of external eurodollar conceit and its more negative counter-effects.

Not only does tight dollars lead to tight RMB therefore increasingly restrained non-government credit, where this all ends up is in persistently slower economic growth (nominal, shown below, as well as in real terms; again, log scales).



Remember, however, that while Chinese non-financial corporates aren’t borrowing at nearly the same pace, China’s vast government sector sure has. To hit various political targets, to just keep the whole thing afloat (managed decline), the only conclusion is rising levels of obvious waste.

Even as credit growth slows down overall, because these negative monetary and credit pressures on the real Chinese economy are constantly restraining potential, maintaining relatively high borrowing levels at general government sectors creates an ever-increasing and increasingly dangerous imbalance of debt.

Some textbooks do mention this peril; those specifically containing references to, say, Japan in the 1980’s.



And I haven’t included the financial sector anywhere here, meaning real estate and property to any degree which only add more to the distressing disparity.

China’s governments can borrow very easily, as most can even during the roughest periods, but to what overall purpose? At some point, saner heads have to call it quits. The Keynesian textbook defines such “stimulus” in only the short run; it isn’t meant to be a permanent financial offset to a chronic economic (small “e”) issue.

But the current Western practice of econometrics does not allow for such a unit root; it cannot concede the possibility of any permanent shock let alone then identify just what it is.

No wonder Xi wants to get ahold of the situation before the situation spirals out of control, especially as already a top-heavy political system about to go back on its (Deng’s) decades-old promise. What do you do if you’re the CCP? In the West, they keep calling for, and worse, expecting, more like 2016. Have Li dust off Keynes and go back at it!

The Chinese are rationally asking, what’s the point? There is clearly “something” preventing recovery from happening, something that really impacted China in 2014 after the first real shockwave had registered in 2011.

This would mean Chinese authorities really have three options, meaning they must choose the least bad: 1. They can sit around and wait for this chronic “something” to magically fix itself, buying more time while they do with more Keynes and hopefully not making the credit problem even more volatile and dangerous as more time ticks by; 2. They can exit the current system and hope by doing so it doesn’t just explode the whole thing; 3. They can try to manage the decline with small fine-tuning measures while simultaneously preparing China for a very different economic therefore political future.

In this context, #3 may not be anywhere close to ideal but it is pretty much the only rational one. And it is equally evident that’s the one Xi has demanded China – therefore the rest of the global economy – must follow.

In 2022, with RMB bank reserves on the decline already to end 2021, the downside message is already being sent across the external/internal China money divide. The real economy’s potential, therefore, likewise set and not in any recovery or inflationary fashion.