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I'm posting this because I just found it, and I think it's an interesting discussion of Chinese monetary policy, and how China attempts to both control its currency exchange rate as well as limit domestic money supply.
From the article:
I don't think all observers would agree that China's inflation is actually "under control", but then the author is tied to Chinese officialdom. I think this article is good background for trying to understand what is going to happen with China's economy.
One item of interest to me is the fact that China's central bank ran out of government bonds to sell from its balance sheet, all the way back in 2005. This would be like the US Federal Reserve running out of Treasurys to sell from its balance sheet, to reign in the money supply -- which is something we've talked about here on iTulip in the context of the Fed monetizing a bunch of MBS that might be difficult to sell back into the market for what it paid. It's interesting to note the ways in which China's central bank has dealt with the problem of running out of "normal" balance sheet assets to sell.
From the article:
Not long after the United States Federal Reserve Board announced its second round of “quantitative easing” (known as QE2), the People’s Bank of China (PBC), China’s central bank, announced two increases of 0.5 percentage points in the required reserve ratio (RRR) of bank deposits. The RRR now stands at 18.5%, a historic high, even in global terms.
...
In September alone, China’s foreign-currency reserves increased by almost $100 billion compared to August. With the global economy recovering, China’s trade surplus began to grow. Moreover, capital inflows increased significantly, owing to real investment opportunities in the high-growth economy and the expectation of renminbi revaluation.
But rapid growth in foreign-exchange reserves means an increase in the domestic money supply, because the PBC issues RMB6.64 (down 3% since June) for every dollar it receives. That means that money supply increase by nearly RMB700 billion in September. The two 50-basis-point RRR increases just locked up the same amount of liquidity.
A country with current-account and capital-account surpluses and increasing foreign-exchange reserves normally sees an excessive money supply and high inflation. But, while excessive money supply is a reality for China – the PBC now holds more than $2.6 trillion in foreign reserves – inflation has been quite moderate so far, thanks to the sterilization policy.
The RRR is only one example of a textbook sterilization instrument. Another is to sell off government bonds held by the central bank in order to take money out of circulation – again, just the opposite of what the Fed is now doing. Because China’s government does not owe much debt to the public, the PBC sold out its holdings of government bonds in 2005. So it had to create something else to sell.
It created so-called “Central Bank Bills,” which commercial banks are supposed to buy voluntarily. When they do, the money they pay is also locked up in the PBC’s accounts. To date, up to 5-6% of total liquidity has been returned to the central bank in this way.
Furthermore, the PBC uses unconventional instruments from time to time, such as “credit ceilings” or “credit quotas” imposed on commercial banks. This may result in “extra reserves,” which commercial banks cannot use to extend their credit lines. Credit quotas imposed early this year have left Chinese commercial banks with 2-3% of extra reserves.
Adding up the impact of the PBC’s sterilization efforts, roughly one-quarter of China’s total monetary base is illiquid. Thus, although China’s total money supply seems excessive, with the M2-to-GDP ratio now at about 190%, the real monetary base is actually much smaller than it appears. As a result, China’s inflation, as well as asset prices, remain under control.
...
In September alone, China’s foreign-currency reserves increased by almost $100 billion compared to August. With the global economy recovering, China’s trade surplus began to grow. Moreover, capital inflows increased significantly, owing to real investment opportunities in the high-growth economy and the expectation of renminbi revaluation.
But rapid growth in foreign-exchange reserves means an increase in the domestic money supply, because the PBC issues RMB6.64 (down 3% since June) for every dollar it receives. That means that money supply increase by nearly RMB700 billion in September. The two 50-basis-point RRR increases just locked up the same amount of liquidity.
A country with current-account and capital-account surpluses and increasing foreign-exchange reserves normally sees an excessive money supply and high inflation. But, while excessive money supply is a reality for China – the PBC now holds more than $2.6 trillion in foreign reserves – inflation has been quite moderate so far, thanks to the sterilization policy.
The RRR is only one example of a textbook sterilization instrument. Another is to sell off government bonds held by the central bank in order to take money out of circulation – again, just the opposite of what the Fed is now doing. Because China’s government does not owe much debt to the public, the PBC sold out its holdings of government bonds in 2005. So it had to create something else to sell.
It created so-called “Central Bank Bills,” which commercial banks are supposed to buy voluntarily. When they do, the money they pay is also locked up in the PBC’s accounts. To date, up to 5-6% of total liquidity has been returned to the central bank in this way.
Furthermore, the PBC uses unconventional instruments from time to time, such as “credit ceilings” or “credit quotas” imposed on commercial banks. This may result in “extra reserves,” which commercial banks cannot use to extend their credit lines. Credit quotas imposed early this year have left Chinese commercial banks with 2-3% of extra reserves.
Adding up the impact of the PBC’s sterilization efforts, roughly one-quarter of China’s total monetary base is illiquid. Thus, although China’s total money supply seems excessive, with the M2-to-GDP ratio now at about 190%, the real monetary base is actually much smaller than it appears. As a result, China’s inflation, as well as asset prices, remain under control.
I don't think all observers would agree that China's inflation is actually "under control", but then the author is tied to Chinese officialdom. I think this article is good background for trying to understand what is going to happen with China's economy.
One item of interest to me is the fact that China's central bank ran out of government bonds to sell from its balance sheet, all the way back in 2005. This would be like the US Federal Reserve running out of Treasurys to sell from its balance sheet, to reign in the money supply -- which is something we've talked about here on iTulip in the context of the Fed monetizing a bunch of MBS that might be difficult to sell back into the market for what it paid. It's interesting to note the ways in which China's central bank has dealt with the problem of running out of "normal" balance sheet assets to sell.
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