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Why money supply is important for dry bulk shippers

Xun Yao Chen, Industrials Analyst

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: Diana Shipping: the most undervalued dry bulk shipping company)

Money supply growth surpasses estimates

For July, M1 (a measurement of money supply that’s very liquid) grew at a year-over-year pace of 9.7%, up from the low of 9.1% in June for this year. M2, which is less liquid than M1, also grew at a faster pace of 14.5%, higher than June’s 14.0%. The two data both beat economists’ estimates of 9.1% growth for M1 and 13.9% for M2. July’s increase likely follows the central bank’s actions in injecting more capital into the financial system to calm the market, and the government announced that it would keep growth stable throughout the rest of 2013 by accelerating public projects.

Shadow banking

Money supply growth hit a low in June, as the central bank in China let the interbank interest rate rise to a record high in order to punish excessive lending and reign in on 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 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. Plus, 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: Dry bulk capacity growth slows further, encouraging sign for later half of 2013)

Implication for China and shippers

July’s data is positive for shipping companies and the market because it assures investors that China will maintain a stable financial system, which is positive 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). Nonetheless, as Diana Shipping Inc. (DSX) mentioned in its earnings call, easy money is now history. Because the central bank is also trying to reign in on the country’s shadow banking system, money supply growth is unlikely to grow as fast as it did. Yet you shouldn’t take this as a negative. Unless we see significant declines in money supply growth, China’s economy can still grow at a pretty good rate. Countries like Japan, the United States, and European nations have historically been able to grow over the long term when M2 was growing below 12%.

(Read more: Why the Baltic Dry Index has decoupled from the Chinese market)

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