Is China’s central bank beginning to believe its own lies?
The People’s Bank of China is reluctant to further reduce the required reserve ratio for fear of such a move resulting in the weakening of the yuan, according to a leaked document.
SCMP, January 25
I do not decry the occasional little piece of official deceit. After all, even the Ten Commandments do not say, “Thou shalt not lie.” They only say, “Thou shalt not bear false witness against thy neighbour.”
Central banks certainly find it useful to tell little white fibs from time to time. They worry that a public loss of confidence in the financial system can feed on itself and make things worse. They therefore like to make soothing noises to forestall misfortune. This constitutes bearing false witness to thy neighbour, not against him. I can’t get worked up about it.
Thus I think it entirely understandable that the PBOC should tell us just now that everything is fine and under control under the guiding hand of President Xi Jinping, even if everything is not actually fine and under control, which is more likely to be the case. I expect this from a central bank.
But what I do not understand is why central bankers should wish to deceive themselves as well as the general public. Yet this seems to be the case at the moment. The PBOC believes its own lies.
Let’s get it straight right away. Statutory reserves in mainland China are not a tool of monetary management. They constitute a central government slush fund built up to rig the foreign exchange rate of the yuan at levels determined by official edict rather than market forces.
For many years this rigged rate was set at too weak a level. The result was a huge foreign trade surplus, all acquired in foreign currencies that are not legal tender in the mainland and that had therefore to be bought up by the PBOC and parked abroad as foreign reserves. At their peak in mid-2014 these foreign reserves amounted to a thumping US$4 trillion.
And here is the big problem the PBOC then faced – if we take US dollars from people because we do not want them to use US dollars within the mainland then we have give them yuan in exchange at the prevailing exchange rate. It will be a lot of money. Where do we get it?
Answer: From the banks because, as the old bank robber said, that’s where the money is.
The PBOC could not, of course, be quite as bald about it as the old bank robber was. It dressed thing up. It told the banks they were actually putting money into statutory reserves, which is an old-fashioned tool of monetary control little used elsewhere these days.
At the height of the foreign reserve build up, the PBOC required banks to put 21 per cent of all their deposits into these statutory reserves, a ratio so ridiculously high that elsewhere it would cause any financial system to freeze up in a juddering halt.
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Elsewhere, however, statutory reserves would be kept cold in the central bank’s vaults, as good practice of this monetary tool requires. In the mainland the money is just pushed back out in the system to pay for mopping up the foreign currency inflow. The truth is that the PBOC’s statutory reserves have no monetary effect at all.
I fully understand why the PBOC should tell the general public a few little white untruths about this in order to pretend that it has its hands firmly on the monetary levers. It is what I expect from central bankers.
But if this leaked memo is right then the PBOC believes its own lies, which I find astounding. Surely they cannot have fooled themselves, can they? We’re in it up to our noses if that’s true.