China’s money supply grew less than estimated, positive for dry bulk stocks?

Market Realist

Money supply and the economy

Money supply reflects the amount of money available in the economy. When money supply is increasing, it will typically increase the availability of loans, which individuals and businesses can borrow to make purchases. The higher the money supply growth, the higher the growth in available funds. On the contrary, if money supply growth slows, it can have a negative impact on economic growth. As dry bulk shipping demand ties closely to China’s economic activity, money supply is an important indicator to follow.

(Read more: Dry bulk capacity growth slows further, encouraging sign for later half of 2013)

Money supply growth misses estimate

For the month of June, money supply (M2) grew at a year-over-year pace of 14.00%—the lowest increase seen for this year. Economists were expecting an average increase of 15.1%. Although money supply missed estimates, the lower increase we’ve seen in June was likely driven by the government’s intention to squeeze out shadow banking. Here’s an example of shadow banking. Say a state-owned company borrows money from the state-run bank at a cheap rate, then re-lends it out to another entity at a higher interest rate. Sometimes, the entity that borrowed money at a higher interest rate from the state-owned companies will re-lend it out at an even higher rate.

Shadow banking

Shadow banking can be a problem if it grows too large. This is because an investment return of 20% or more is really hard to come by. When economic growth slows and profits suffer, lenders will ask borrowers to return the money. But in several cases, borrowers are unlikely to be able to pay back the principal. Additionally, greed can drive lenders to lend more than they can afford, because shadow banking is unregulated. Several lenders could face liquidity issues when they realize they’ve not set aside enough cushion to pay for day-to-day operations or weather an economic slowdown.

(Read more: Falling bulk carrier orderbook marks progression)

Implication for China and shippers

While investors may see June’s figure as a slight negative for dry bulk shippers such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Knightsbridge Tankers Ltd. (VLCCF), Eagle Bulk Shipping Inc. (EGLE), and Navios Maritime Partners LP (NMM), China’s economy has historically been able to grow when money supply growth fell (with 2008 being the exception). So investors may not want to rely solely on money supply as an indicator of economic expansion and recovery in China. On the other hand, investors could use money supply as an early indicator of economic recovery, since economic recoveries often start with more money supplied by the central bank or government stimulus.

(Read more: Panamax vessel price reveals low dry bulk orders, negative implication)

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