Commentary: The Role of Money Supply in Reviving China’s Stock Market

The Chinese mainland stock market recently experienced a strong rally around the National Day holiday, which started on October 1. This marked a change after four months of decline, influenced primarily by the Federal Reserve beginning a cycle of interest rate cuts[para. 1]. In recent years, the performance of the Chinese market has negatively correlated with the health of the U.S. economy, where a bear market in China began as the U.S. economy entered a phase of high growth, inflation, and interest rates in February 2021[para. 2]. However, since the start of 2023, signs of a weakening U.S. economy grew, shown by indicators like the purchasing managers’ index and consumer price index. A significant 50-basis-point rate cut by the U.S. Fed on September 18 signaled a slowdown, which coincided with a rebound in China's market[para. 3].

This correlation occurs because changes in the external environment can prompt shifts in China’s policy priorities[para. 4]. China’s monetary policy has thus transitioned from stabilizing exchange rates to emphasizing growth. Historically, China could not lower interest rates due to high U.S. rates putting depreciation pressure on the yuan[para. 5]. However, China's central bank has accelerated interest rate cuts beginning in the latter half of the year. A reasonable increase in prices is now a key monetary policy goal, as lower real interest rates help reduce deflationary expectations and boost investor risk appetite, leading to a potential stock market rally[para. 6]. If external demand weakens, Beijing may intensify fiscal expansion to stimulate domestic demand, with historical data indicating a shift from export growth correlates with a market transition from bear to bull[para. 7]. In scenarios where U.S. trade tensions, such as possible tariff increases from a re-elected Donald Trump, increase pressure on Chinese exports, China's fiscal measures may become more proactive[para. 8].

Since September 24, market momentum has improved due to better policy expectations rather than fundamental economic improvements. For this upturn to sustain, growth in M1, a measure of money supply including cash and other liquids, must be reversed[para. 9]. As of October 8, the ratio of free-float market capitalization to M1 is close to peak 2015 levels, suggesting unsustainability without M1 growth. However, the broader M2 ratio indicates deeper stock market potential, with households having room to shift funds into stocks[para. 10]. Recently, the difference in growth rates between corporate and household deposits widened, and new time deposits decreased consecutively, suggesting a possible bottoming out of M1 growth[para. 11]. China's deflation pressures stem not from credit contraction but stagnating money circulation, due to fiscal constraints on local governments and an ongoing real estate downturn[para. 12].

To address local government debts, measures like debt swaps could reduce burdens significantly, helped by financial institution support. This could resolve debt through extensions, optimizations, and restructuring[para. 13]. In real estate, lowering existing mortgage rates can enhance purchasing power, indirectly shifting non-M1 M2 parts into M1. Furthermore, a new initiative aims at renovating 1 million homes, potentially stabilizing housing prices in key cities and easing deflationary expectations, which aids M1 growth rebound prospects[para. 15]. Xu Xiaoqing, director of macro strategy at DH Fund Management Co. Ltd., contributed viewpoints that highlight these market dynamics[para. 22].