China's financial markets have been experiencing tighter liquidity as a result of deliberate government policy.[Hong Kong company registration]

Tighter liquidity is, in effect, tighter monetary policy. Economist Milton Friedman believed that the best way to judge monetary policy is not by the inputs, such as the monetary policy rate, but by outputs, such as growth and inflation. This is because expectations of future policy settings, which are harder to measure, play a bigger role in driving aggregate demand than current policy settings.

Managing expectations is important. Chinese economic policy has shifted since the new leadership took over in late 2012, with a noticeable de-emphasis on GDP growth. President Xi Jinping has stated that local government officials should not be judged solely on GDP growth.

Expectations that the government is willing to let growth fall below trend is arguably more concerning than the liquidity crunch. Stock investors seem to agree. Financial stocks have fallen since the liquidity problems emerged, but they are roughly back to where they were in early 2012. However, the Shanghai composite index has fallen further, suggesting that investors fear slowing demand more than the credit crunch.[Set Up Company Hong Kong]

The central bank is actually using monetary policy to deflate a credit bubble. Estimates of total credit in China vary, but one popular measure - the stock of non-goverment, non-financial debt as a share of GDP - rose above 200 percent in early 2013, a steady rise from 140 percent at the end of 2008. This rise in credit is funded partly by "wealth management products" investments that pay higher returns than the 3 percent deposit rate.[Hong Kong Company Formation]

These products are short term - many mature in under a month - and were originally designed to help property developers weather liquidity constraints, but their scope has expanded such that an estimated 40 percent of outstanding wealth management products were collateralized with non-standard assets in 2012.