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This Chart Shows Why China Might Not Be Able to Reverse Its Economic Slide

China's money supply is drying up, a sign that it could be hard to reverse its economic slide.

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China has devalued its currency, the renminbi, and injected cash into its financial system, but that hasn’t been enough to stem the continuing fall in the Chinese stock market. On Tuesday, the Shanghai Composite Index fell 6.2 percent to 3,748 points, down 27 percent off its peak in June. This follows last week’s global market panic, when Beijing allowed the value of its currency to drop, a step it had avoided for more than two decades.

Tuesday’s equities slide is yet another sign of fundamental weakness within China’s economy, the world’s second largest. In July, exports were down 8.3 percent year-over-year. China could miss its 7 percent growth target for 2015. But according to Steve Hanke, a professor of applied economics at Johns Hopkins University, the real indicator of the extent of China’s economic woes is the amount of money circulating in its financial system. And that is down dramatically.

Since a peak in 2009, the amount of money in China’s financial system has been trending lower. According to Hanke, money supply drives nominal gross domestic product growth, or GDP that isn’t adjusted for inflation. If there’s less money in the system — as the chart below, provided by Hanke, demonstrates — economic growth is likely to go down.

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“They’re not going to able to get out of this,” Hanke told Foreign Policy. “They won’t turn a dial and switch the thing around.”

History provides evidence for Hanke’s prediction. Prior to the Great Depression, the money supply in the United States dried up. It took a huge increase in government spending to build World War II weapons to end it.

The Great Recession also shows the importance of money supply. When Lehman Brothers in 2008 collapsed, credit disappeared. To offset this, the U.S. Federal Reserve injected trillions of dollars into the American economy in an attempt to jump-start economic growth.

The People’s Bank of China on Tuesday did the same, putting $18.77 billion into China’s financial system. But it wasn’t enough to stop Chinese shares from tanking.

“Everyone goes on about fiscal policy, but the thing that matters is where the money is going,” Hanke said. “I’m not surprised China is slowing down.”

Photo credit: Johannes Eisele/Getty Images

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