Diminished Bang for the Yuan

The money multiplier measures an economy’s expansion relative to total spending. Thanks to velocity, the number of times a dollar (or other currency) is spent during a year, the multiplier effect has historically been greater than positive one for most economies. This means a 1 per cent spending increase would translate into a 1-plus per cent boost to economic growth. Since the financial crisis, however, velocity has plunged below one in most developed economies. Blame demographics, bank regulations or a general unwillingness to take on credit; US monetary velocity plunged below one in 2009 and has stalled there ever since.

Lackluster velocity has major implications for government stimulus programs, particularly for China, where Beijing has historically relied on debt growth to support their economic expansion. As of the end of last year, China’s corporate and household debt together total more than 220 per cent of GDP.  China’s leadership embarked on major capital programs funded by government debt to keep the Chinese workforce employed. Recently, however, President Xi and his Politburo have gotten diminished bang for their buck as the ratio of economic expansion to debt growth has fallen. In an environment of weaker velocity and less productive projects, debt will need to rise more rapidly to sustain an acceptable level of economic growth. This will be the situation not just in China but in the rest of the aging developed world as well.

Jack Ablin, CFA
Founding Partner and Chief Investment Officer