Beijing weaves tangled web of yuan deceit
with Jake van der Kamp
China raised banks' required reserves yesterday for the fourth time this year, extending the fight against excessive liquidity and stubbornly high inflation in the world's second largest economy.
SCMP, April 18
That's how they describe it in Beijing anyway. But I think the facts tell a different story. Here is how I would rephrase that first paragraph: the Peoples Bank of China raised the required reserves of commercial banks yesterday for the fourth time this year so that it could continue to rig the yuan at an artificial exchange rate despite an enormous imbalance on the balance of payments. It still pretends that this is an inflation-fighting move.
Let's review some history here first, which is always best done with charts. The first one shows you that, yes indeed, inflation on the mainland is rising again. But it is still not as high as it was in early 2008 and certainly nowhere near the peaks reached in 1989 and 1994.
The chart also shows that historically the PBOC has used the interest rate it charges on loans to financial institutions as a way of resisting inflation but always belatedly and never very aggressively. It prefers direct ministerial orders - Thou shalt not lend no more. The latest interest rate movements here certainly do not seem to indicate any policy change or alarm in the monetary authority.
Yet the second chart appears to tell a different story. The statutory reserve ratio, the percentage of deposits that commercial banks must keep out of circulation by placing them with the central bank, has risen to record heights, far above where it stood in those two inflation peaks of 1989 and 1994.
This is odd because the statutory reserve is meant to be a background monetary tool. Central banks establish it for the longer term and change it only infrequently. For shorter-term control measures they use interest rates and market operations.
It almost seems that the PBOC is trying a monetary experiment here, making the statutory reserve the primary short-term tool of monetary control and abandoning interest rate measures or consigning them to a far less important role. If this is so, it is a very interesting experiment and will be closely observed by central bankers around the world.
But it is actually expedient, not experiment. What has happened here is that the PBOC has experienced a huge wave of foreign currency, mostly from a surging trade surplus, rolling into China and seeking conversion into yuan. It is trying to resist this pressure.
Left to themselves the inflows would by now have pushed the yuan to much stronger levels and slowed down the export boom by forcing export prices up. This was unwelcome and the PBOC adopted a two-pronged approach to deal with it. It mops up the inflow by supplying yuan to meet the demand and it has also allowed the yuan to rise gradually.
But this gradual rise has only made many watchers believe that the currency will keep rising and they are therefore pouring in more money to take advantage of it. As a result, the inflows, now more speculative in character, are running at about a trillion yuan a quarter, near the record of early 2008. Where is the PBOC to find all the money to sterilise these inflows?
The answer is the classic one adopted by all bank robbers. The money can be found in the banks. What the PBOC does every time it needs more yuan to rig the currency is squeeze the commercial banks by raising the statutory reserve requirement another notch.
This has no inflation-fighting effect at all. It would only have one if the yuan were kept in reserve, cold in the vault. But instead it is given to all the exporters and speculators who come calling with US dollars in their hands. They immediately put it back into circulation. And with its now huge yuan liabilities the PBOC also finds it more difficult to use the interest rate tool against inflation. Oh, what tangled webs we weave when first we practise to deceive.