China’s central bank announced yesterday it would cut banks’ reserve requirement ratio, offering yet another sign that Beijing is committed to monetary easing to revive the economy. SCMP, March 1 My crystal ball is clearing up. Normally it’s cloudy and I cannot see much in it but now it is plainly showing me signs that Beijing will not be able to stop further weakness in the yuan’s exchange rate. One thing in particular makes that crystal ball turn clear on the future. It is when government officials try to hide what it shows me. The excerpt above is an example. You get the impression from it that bureaucrats of more than normal human intellect and responsibility have determined after careful and thorough examination of the conditions that reducing statutory reserve requirements imposed on banks is the wisest course to continued prosperity. One thing in particular makes that crystal ball turn clear on the future. It is when government officials try to hide what it shows me What we actually have here is a purely reactive measure forced on the People’s Bank of China by its increasingly desperate attempts to keep rigging the yuan’s exchange rate while at the same time trying to control interest rates and capital flows. It cannot be done and the only way out of this dilemma for the PBOC is to try to pull the wool over our eyes. This has the effect of pulling the wool off my crystal ball. What it all comes down to is that Beijing built up huge foreign reserves, almost US$4 trillion at their peak, with a deliberate policy of encouraging big trade surpluses through a rigged exchange rate. The build-up was achieved by taking foreign currency inflows from the commercial banks and crediting these banks on the PBOC’s books with a matching liability misnamed as statutory reserve deposits. There was no monetary tightening in this, just a balance sheet juggle. But capital flight is now the theme on the mainland’s balance of payments and the foreign reserve build-up is now being unwound. The misnamed matching liabilities are consequently being reversed at the same pace and, just as there was no monetary tightening on the way up, there is no easing on the way down. The two charts show you the trend in two different ways. The first one plots the statutory reserve ratio against foreign reserves and the other plots it against the annual trend of the balance of payments. It is the same story on both charts. The reserve ratio is a purely reactive measure to up and down changes in foreign reserves and Beijing is increasingly losing control over whether those foreign reserves go up or down. In this newspaper we recently highlighted how the PBOC has stopped issuing what might be an embarrassing data series on bank foreign exchange holdings. I do indeed suspect it was done to avoid embarrassment but I don’t think anything much was hidden that is not visible many other ways. And what most stands out is the act of pretence itself. It tells you that the bureaucrats are worried and they don’t really know what to do. As they are at the same time saying that continued yuan weakness is not in prospect, I read their statements as saying that it very much is.