By Hu Rongping (胡蓉萍)
Issue 612, March 25, 2013
Nation, page 16
Translated by Zhu Na
Original article: [Chinese]

By the end of February, China’s total amount of monetary assets available in the economy (M2) had reached 99.86 trillion yuan, according to statistics from the Central Bank.

This means China has the highest M2 in the world – 1.5 times that of the runner-up United States.

Growing from 16 trillion yuan at the beginning of 2002 to almost 100 trillion yuan today, China’s M2 is once again causing controversy over whether currency is being over-issued.

But before debating, it’s necessary to understand what M2 really is. M2 is a broader classification for money than M1. Economists use M2 when looking to quantify the amount of money in circulation and trying to explain different monetary conditions.

The difference in M2 levels between different countries is the result of many factors. Therefore, simply using M2 and GDP to measure whether a country’s currency is over-issued is a questionable approach.

In economics the broad classification of M2 is different from the cash and coins people generally regard as currency. This physical money is the currency issued to the public by the Central Bank. In economics, it’s known as M0.

Compared to the major countries in the world, China’s M0 is relatively low. At the end of 2012, the U.S., Eurozone and Japan each had M0 of about $1 trillion. China’s was about $866 billion. China’s M0/GDP ratio was 0.11, just slightly higher than U.S. and Eurozone’s. This is because Chinese people are more inclined to use cash, while developed countries more often use bank cards, checks or other non-cash payment methods.

M1 includes M0 plus checking and other accounts deposits that can be quickly converted to cash. Since M1 has immediate purchasing and payment power, it’s what directly impacts commodity prices, not M2. 

In 2012, China’s M1 was 30.9 trillion yuan with the ratio to GDP at 0.59. This was much higher than the U.S.’s 0.16, far lower than Japan’s 1.15 and somewhat close to the Eurozone’s 0.52. Looking at the growth from 2008 to 2012, China’s M1/GDP had an average annual increase of 0.7 percent, compared to 9.9 percent in U.S., 3.8 percent in Japan and 4.6 percent in the Eurozone. 

But the measure that gets everyone’s attention is M2. 

M2 is M1 plus all time-related deposits, savings deposits, and non-institutional money-market funds. Most of M2 isn’t real purchasing power or currency issued directly by the Central Bank. However, since M2 can be transferred to real purchasing power through M0 or M1, an increase in M2 reflects an increase in people’s wealth to a large degree.

In recent years, China’s M2 had relatively rapid growth. From 2008 to 2012, China’s M0 only increased by 2.4 trillion yuan, while demand deposits increased by 13.2 trillion yuan and fixed term deposits increased by 41.5 trillion yuan. The increase in fixed term deposits largely comes from growth in disposable income and people’s increasing tendency to save money. China’s national savings rate went from 37.9 percent in 1992 to 51.1 percent in 2011. 

Another important point is that since China’s Reform & Opening Up, all kinds of production factors originally allocated through central planning have gradually entered the open market. Land and housing, for instance, weren’t sold outright in the past. So after they entered the open market and got a price tag, they had value and the demand for currency became greater.  

Since China is in the process of economic monetization, M2’s growth rate will be relatively faster than that of developed countries. European and American economies now enjoy relative stability, but only after more than 100 years of development.

Many have recently focused on the M2/GDP indicator. In 2002, this indicator was 1.54 in China, and now it has reached 2.0, which is relatively high internationally. But in fact, M2/GDP in Asia is generally higher than European and American countries. At the end of 2011, Japan, South Korean and Singapore had an M2/GDP rate of 1.7, 1.4, and1.4 respectively – all much higher than the 0.6 in the U.S. and 0.9 in the Eurozone.

The M2 level is the result of many factors, so simply the M2/GDP to measure whether a country’s currency is over-issued is a bit dubious. 

Firstly, M2 and GDP are not comparable. Classification of M2 data is from a certain point in time, whereas GDP is cumulative.

Secondly, the statistical approach to measure M2 varies between different countries, so they shouldn’t be compared directly. If calculated according to the U.S. method, China’s M2 in 2012 would only have been 60 trillion yuan (rather than nearly 100 trillion). This is mainly because M2 in the U.S. doesn’t include fixed deposits of over $100,000 while China’s M2 includes all fixed term deposits. 

Of course, the yuan still isn’t freely convertible, which is also pushing China’s M2 higher. This has led RMB created through domestic economic development to be stockpiled at home, while at the same time, a large amount of foreign currency has been exchanged to RMB and invested in in China.

Historically, M2 has correlated with economic growth, employment, prices and other major economic indicators. Therefore, it’s often used as a metric for monetary policy regulation.

But now many developed countries like the U.S. no longer use M2 for regulation because they’ve found it has no real connection to the goal of keeping prices stable.