China’s Banking Assets Are $52 Trillion, Growing By $40 Trillion Since 2008: “This Is What Hyper MMT Looks Like”


By Tyler Durden,

By Eric Peters, CIO of One River Asset Management


“The interaction of inflation-focused monetary policies in the west and China’s mercantilist model created what I call The Refrigeration Mode,” said the CIO, sitting atop his prodigious pile. “The process has been ongoing for twenty years,” he continued. “The inflation-focused policy framework is based on the fallacy that you can model an economy using an equilibrium framework,” he said. “Wicksell was the father of classical equilibrium in economics. He observed that for a pure credit economy - with no external gold backing for money, just credit-backed deposits – there were no clear forces that would drive the system toward equilibrium. To the 19th century Wicksell, a pure credit economy was a fictitious, futuristic concept, but it is effectively what we have today - and it is a path dependent system.”

“What is a path dependent system?” asked the CIO, not waiting for my answer. “Take the male driver when lost. Despite all evidence around him, the male believes he is not lost. He is, of course. And yet has no need for a map. The male is merely taking a different route, maybe a better a route to the same inevitable, incorrect destination. That destination being equilibrium. It’s all taking place in the male’s head. The reality on the road, meanwhile, is rather different. He turned left at the fork in the road when he should have gone right. There is, now, no natural force - other than blind luck and a tactful passenger - which can rescue him. Further wrong turns, and his destiny await. His destination is path dependent.”

“So now consider a simplified schematic,” said the CIO. “The economy receives a positive supply shock which lowers inflation and allows rates to fall. This brings forward consumption. Consumers borrow and spend. Asset prices go up. Financiers get excited. More intermediation and engineering. We get inevitable excess. Policy tightens. This causes a financial crisis, which the central bank is forced to respond to - with the fear of deflation in mind - and rates fall further. The net effect is that nominal and real rates ratchet lower in a path-dependent fashion. And this leads to a monetary policy that is so lost we’ve had to create a new word to describe our bizarre destination: a world of financialization or more appropriately, hyper-financialization. It is the optimization of the economy around finance and asset prices - the fuel for the Occupy Wall Street manifesto.”

“Now let’s look at the other half of this system: China’s mercantile model,” said the CIO. “We all vaguely know the story here - we all tried shorting it at one point or another. China discovered the Magic Money Tree. They used it to build a manufacturing empire and stopped the magic escaping from the capital account. This was MMT used in anger. They repressed the exchange rate to take export market share and accumulated FX reserves in the process. These were recycled into US Treasuries, supporting lower US interest rates. They repressed depositors with negative real returns on deposits to favor investment over consumption. The consumption share of GDP has remained depressed throughout, subjugated to investment exports and government spending. No wonder property became the savings vehicle of choice - and seemed to be an everlasting bubble. Free money allowed a massively accelerated pace of industrial development, especially after China joined the WTO in 2001.”

“China’s rapid industrialization and hunger for global market share kept deflationary pressure on durable goods prices for thirty years, helping to keep consumer price inflation and interest rates lower in the West. And the beauty of the Magic Money Tree was that China could insulate its highly cyclical industry from any default cycle. It monetized bad debt and preserved unprotected, deflationary capacity. The stock of money ballooned. Banking assets are now around $52 trillion. They’ve grown by about $40 trillion since 2008. They’re now twice the size of the US banking system and China’s banks have added the equivalent of the US banking systems in just eight years. This is what hyper MMT looks like.”

“The net result is that western monetary policy and China’s mercantile model fed off one another to give us this Alice in Wonderland ‘through-the-looking-glass’ transformation of massive monetary growth into a deflationary mechanism: The Refrigeration Mode. Both sides got what they wanted: China leapfrogging industrial development, and the US got low inflation in the great moderation. But it had side effects. A massive monetary overhang in China, hyper financialization in the US. These extremes are now biting back on the system through the political economy.”

“The Deflationary D’s may still be with us (debt, demographics, disruption, digitization), but the system dynamic is becoming inflationary and there are some new supply side shocks that aren’t deflationary for a change. Both sides are in (re)flux. On the macro policy side, we are seeing powerful social reactions to the extremes produced by The Refrigeration Mode. These extremes are feeding into the political economy. Whether it’s the ‘Tax the Rich’ dress at the Met Gala, politicians and celebrities at climate change marches around the world, or bipartisan support for China containment, the challenge to the status quo is clear and present. The COVID crisis merely poured petrol on it.”

“It means fiscal policy is back in the driver’s seat - just as central banks put an inflationary bias into their reaction functions. Future bailouts are coming via Main Street, as much as Wall Street. And when monetary and fiscal policy combine, policy becomes more directly inflationary in CPI terms, not simply in asset price terms.”

“On the China side, the model is pivoting. Common prosperity in its ‘dual circulation strategy’ shifts the emphasis from a reliance on exports to a focus on the domestic consumer in regional markets. A digital currency will be presented as a haven of stability, while other economies appear to be debasing their own currencies. Deleveraging is a goal - so more defaults will be allowed. Profits will take precedence to export market share. So expect to see China continuing to export more goods priced at a premium, leaning against commodity price inflation. Taken together, all these changes transform The Refrigeration Mode into its reverse: A Heat Pump.”

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