Last week’s release of disappointing economic andtrade data for July has, predictably, renewed calls for additional stimulus.  In May, Beijing ramped up its support for the economy, and observers had expected activity to pick up by last month.

Why has the economy so far failed to respond?  There are various reasons, but perhaps the most important is that the country is running out ofmoney for stimulus.

At first glance, that proposition seems preposterous.  After all, the People’s Bank of China, the central bank, held $3.24 trillion of foreign currency reserves at the end of the first half of this year.  Yet foreign currency, no matter how plentiful, has limited usefulness in a local currency crisis.  In any event, the PBOC’s foreign currency holdings are almost evenly matched with renminbi-denominated liabilities that were incurred to acquire all those dollars, pounds, euros, and yen.  As a result, the central bank cannot use the reserves without driving itself deep—actually, deeper—into insolvency.

The recent slight decline in the value of the renminbi versus the dollar has decreased the amount of the PBOC’s liabilities in relations to its assets and has therefore marginally strengthened its balance sheet, but the central bank still does not have the flexibility to use its reserves as it pleases.  Therefore, a massive foreign currency injection into the economy, even if it would work, is not in the cards.

Nonetheless, the central bank could, as it did beginning in 2003, inject a limited amount of reserves into the country’s state banks to permit them to lend more money.  The last stimulus program, announced at the end of 2008, created growth primarily because the state banks, at Beijing’s direction, embarked on an extraordinary lending spree.  In 2009, for instance, new local currency lending reached a record 9.59 trillion yuan, just about double that of 2008.  The loan-a-thon continued in 2010 and 2011 as the economy got hooked on easy credit.

The lending spree has ended, however.  The state banks cannot fund all the hundreds of new projects—500 according to one count—that Beijing and local governments have announced in recent months.  Why?  Many of the loans central technocrats forced bankers to make since 2008 will never be repaid.

The China Banking Regulatory Commission claimed the banks’ nonperforming loan ratio at the end of the first quarter was 0.9%, but even the regulator expresses doubts about its own figure.  And the rapid buildup of bad loans since the end of 2008 will have consequences.

Banks, despite what the CBRC says, are burdened by questionable loans and will have to scrounge for funding before they can make long-term commitments for stimulus projects.  Tsinghua University’s Patrick Chovanec reports that this year banks have managed to make new loans but most of them have been short-term.  Moreover, he notes these financial institutions will have problems soon as they will need their remaining liquidity to refinance wealth management and property trust products coming due.  In short, they will scramble just to find the cash for existing commitments.  Funds for new projects—the ones that represent growth—will be scarce.  In July, not surprisingly, new renminbi lending fell, dropping below all estimates to 540.1 billion yuan from 919.8 billion in June.

In any event, economists believe infrastructure—stimulus—spending will only make up for declining demand from private businesses.  As the Wall Street Journal’s Tom Orlik reports, such spending is not expected to stimulate growth.

Despite everything, some cities are getting funding for new projects, but that’s only because the CBRC has essentially ordered the banks to shovel funds to the uncreditworthy local government financing vehicles.  Just months ago, Chovanec notes, these borrowers were on the “do-not-lend list.”  Yet many localities, even after the lending taps were opened, are still cash-strapped.

So how bad is the situation?  Anne Stevenson-Yang of J Capital Research reports that the tax bureau of one of China’s largest cities “has no money.”  Its officials, incredibly, have been told to collect their own salaries from taxpayers directly.  The breakdown of government in that city is also evident across the country, where localities are now desperate for revenue......