Tough talk just a screen for cheap way to rig yuan rate
with Jake van der Kamp
Beijing yesterday told banks to set aside more money as reserves, the first such order this year and a signal that despite slowing global growth policymakers are not tempted to loosen lending restrictions.
SCMP January 17
'Got it? We're tough, we're mean and we're nasty and when we say that we're tough we mean that we're tough and this time we really mean it, got it? We're not pussyfootin' around no more. We're mean and nasty and we mean it 'cause we ... blah, blah, blah blah ...'
I think it's time once again to invoke my Rule No.3 of central banking - commitment to any policy stance exists in inverse proportion to the number of times it is pledged.
They've been talking up a storm in Beijing recently about how they are going to clamp down on overheating in the economy, stop banks from lending too much and squeeze inflation out of the system, but I've heard it repeated too often. My Rule No.3 now indicates that it's just talk and they haven't really squeezed up the courage for a real squeeze.
Take this matter of the People's Bank of China raising the statutory reserve requirement for commercial banks to 15 per cent of deposits ' ... to continue strengthening management of liquidity in the banking system and curb excessive credit growth'.
A higher reserve requirement could indeed do this but only if the money were locked away cold so that it does not recirculate through the system.
Now, look at the outline below of the PBOC's balance sheet as of November. The biggest single item under assets is 12.2 trillion yuan in net foreign assets, which represents the nation's ballooning foreign reserves. Nothing else in the asset column comes even close to this.
Next, turn to the liabilities side of this balance sheet. Here the single largest item is more than six trillion yuan in financial institution reserves, which is up by more than two trillion yuan over the last years with all those increases in the reserve ratio.
And here is the big question. Do you see a balancing item on the assets side of the balance sheet marked 'Financial institution reserves kept cold'? Do you see anything that could even be taken as this?
No, you do not, and there is a good reason for it. These reserves are not kept cold. The reason that the PBOC keeps upping the reserve ratio is to raise cheap money to sterilise the continuing US dollar inflow from the mainland's huge trade surplus, which it then sticks into foreign reserves.
It has to do this because the alternative is to let the yuan rise against the dollar at a much faster rate than Beijing is willing to tolerate at the moment.
The PBOC has a difficulty here, however. Two years ago, it raised the necessary yuan for this exercise by issuing yuan bonds that carried interest rates much lower than comparable US dollar rates. The difference between the two rates then offset the currency translation loss on the slowly rising yuan.
But it does not work any longer. As the chart shows, these yuan and US dollar rates are now roughly the same. There is no longer an offset. Thus, the PBOC had to look for another source of funding and the obvious one is statutory reserves because only a derisory interest rate is paid on these reserves.
The problem with this, however, is that the reserves cannot then be held cold. They are being used to recirculate money back through the system to pay for that US dollar acquisition. The reserve ratio, whether it goes up or down, has no monetary effect at all.
Thus, it is cynical nonsense for the PBOC people to say that they have upped the reserve ratio in order to strengthen management of liquidity and curb excessive credit growth.
They did it because it was a convenient way to rig the yuan exchange rate when other ways would lose them money. The cover story is simply not true and they know it.
It's just empty tough talk, pure blah, blah, blah, blah ... I say they don't have the guts for a real clampdown.