If you want a financial guard dog to bite, don't feed it with hot money

PUBLISHED : Sunday, 05 December, 2010, 12:00am
UPDATED : Sunday, 05 December, 2010, 12:00am

Why there is a need to release so much money into the economy and where it is being used is unclear.

'It's always a mystery,' said Lu Zhengwei , a senior economist for Industrial Bank.

To get a full picture of the mainland's money supply would take a very large project beyond the scope of an individual researcher - and it has yet to be done, he said.

SCMP, December 1

Oh what a mystery, what a complete enigma, how difficult a riddle ... the question, that is, of how this Mr Lu can call himself an economist, a senior one too, take note. Maybe I'll never puzzle it out.

The answer to the question of why money supply growth in China is so high is simple enough. Beijing cheats. What it calls cooling down measures are nothing of the sort. Perhaps Mr Lu knows it too and he is just ducking and diving. Some truths are best ... well, you know.

Let me point out here that the famous American bank robber, Willie Sutton, was a better monetary economist than Mr Lu. Asked why he robbed banks he said, 'Because that's where the money is.'

Spot on. We shall start where the money is. It is banks that directly make the money supply grow by lending out money, taking that money back in again as deposits, lending it out once more and so on.

Central banks, the People's Bank of China in this case, can call on several effective tools for curbing money supply growth, effective, that is, if it wishes to make them effective.

The most notable one is the statutory reserve requirement. The idea here is that commercial banks must set aside untouched a certain percentage of every deposit they take in. Now look at the first chart. The statutory reserve requirement imposed by the PBOC on commercial banks has been raised steadily to a thumping 18 per cent. Surely this should be enough to slow down the hot money circle? Surely not. The PBOC has broken the rules. It has not left the money untouched.

There is at present a huge inflow of US dollars from the trade and investment surplus and the PBOC uses the statutory reserves to buy up these US dollars and invest them in US Treasury bills.

The US dollar holders get the yuan from the statutory reserves in exchange and they just deposit this money with the commercial banks again. Thus there are effectively no statutory reserves at all. It's an illusion. The talk of monetary prudence is just hot air.

What makes it worse is that the PBOC does not want to pay banks a great deal for taking the supposed 'reserve' money from them, which is understandable, given that it has liabilities to them of more than 11 trillion yuan (HK$12.81 trillion) in 'reserves' alone, not to mention another 4.5 trillion yuan in bonds. Interest on this could be quite a burden. But it is not. The second chart shows you that the PBOC pays a record low interest rate on this money of just 0.72 per cent at present.

I wish I could be a PBOC, taking what I want from the banks, paying them only what I want to pay them for it. Wonderful game. How do I get cut in? What a superb irony. The snarling watchdog that Beijing keeps to guard against hot money speculators is feeding out of their hands and helping them to the treasure chest. Oh, yes, what a mystery we have here.