Jake's View

PBOC monetary management just official rigging of the exchange rate

PUBLISHED : Thursday, 29 October, 2015, 12:42am
UPDATED : Monday, 16 November, 2015, 4:43pm

Cutting banks' reserve requirements ratio by 0.5 per cent would release 800 billion yuan of funds into the market with banks keeping less money in reserves, said ...

SCMP, October 24

Ignore who happened to say it this time. They all say it all the time across the border. But let's go through how it really works.

We start with the mainland widget manufacturer whose sales of widgets abroad are greater than the cost of the raw materials and components he purchased abroad for making these widgets.

He now has a surfeit of US dollars on his hands (it's always US dollars). He cannot use those dollars for purchases or investments at home. Everything at home is denominated in yuan. He also does not want to buy anything more abroad just now, either for the company or himself. He already has three Ferraris.

He therefore looks for someone who will take the US dollars off his hands in exchange for yuan and he finds this search difficult.

Not only does Beijing officially prohibit private transactions in foreign currency but everyone else in the mainland seems to be in the same fix. From 2007 to 2010, for instance, balance of payments inflows of foreign currency averaged US$450 billion a year.

In fact, there is only one entity that can take our man's US dollars and give him yuan for it. That entity is the state itself, in the form of the central bank, the Peoples Bank of China.

But while this poses the PBOC no great difficulty for a million here and a million there, the story is quite different with hundreds of billions a year. Where is the PBOC to find the money?

The answer is the classic old bank robber's one. The PBOC goes to the banks because that's where the money is.

The PBOC, however, does not wish to declare in broad daylight that it is a bank robber. Thus it calls this particular form of robbery something else.

It says that it is exercising monetary discipline and it imposes a statutory reserve requirement. For every 100 yuan that a bank accepts in deposits, it must put six yuan away in a special reserve with the PBOC, which it cannot touch.

This at least was the ratio in 2000. From there it was steadily raised to as high as 21 per cent. At their height, these reserves totalled 29 trillion yuan. That is 29,000,000,000,000 yuan. Small change, you know.

To put a further perspective on this, statutory reserves are an old-fashioned tool of monetary control practised in only a few countries, where the ratio is routinely less than 5 per cent. A ratio of 21 per cent is so high that it would ordinarily put any economy into the deep freeze.

But this does not happen in the mainland for the very good reason that the money is not kept in reserve. The PBOC immediately pushes it out into the system again to buy up those huge inflows of US dollars and stack them abroad as foreign reserves.

The monetary effect of the entire exercise is therefore nil. The money was never taken out of the system but only passed once through the PBOC's hands before being pumped straight back in.

This tells you that there is also no magic 800 billion yuan suddenly released to the system if foreign currency inflows turn into outflows and the statutory reserve requirement is then reduced. The money is already in the system. It always was.

What we have here is just PBOC bafflegab to disguise as prudent monetary management what is in fact massive official rigging of the yuan's foreign exchange rate.