Jake's View

Talk of different policy tools makes no difference at all

It is indeed true that the PBOC is not shrinking its balance sheet like the US Federal Reserve. Instead it has been trashing that balance sheet.

PUBLISHED : Sunday, 25 June, 2017, 1:22am
UPDATED : Sunday, 25 June, 2017, 1:22am

The central bank will not take action to shrink its balance sheet like the US Federal Reserve, as it does not face the same pressures due to its use of different policy tools, an adviser to the People’s Bank of China said yesterday.

Reuters, SCMP, June 23

I like the imagery there – the leather-aproned craftsman in his sunlit workshop carefully selecting the tools he needs for the job in hand and then wielding them with delicate precision to fashion an instrument of wonder.

What we actually have in the Fed is a group of bemused academics, totally at sea in the real world, hoping against reason that they can painlessly unwind a deeply flawed stimulus programme that stimulated financial speculation rather than the productive economy. This is what is meant by “shrink its balance sheet”.

Four years after China’s cash crunch, has ‘Mother PBOC’ spoiled her ‘kids’?

And what we have in the PBOC is a desperate firefighter rushing with his fire hose from one new outbreak of flame to the next, panic reaction masquerading as considered monetary policy.

Policy tools, hah!

But it is indeed true that the PBOC is not shrinking its balance sheet. As the chart shows, total assets of 34.3 trillion yuan (HK$39.1 trillion) are very little below their all-time high. To put things into perspective, this is the equivalent of 44.5 per cent of gross domestic product. The corresponding figure for the Fed is half as much.

The chart also reveals what has happened here. Yes, the foreign assets have declined markedly since mid-2015. Take note, by the way, that they are still declining in yuan terms, still being withdrawn. The fact that their US dollar value as foreign reserves has risen only reflects exchange rate adjustments.

But look at the red line on the chart. That stinging reserve ratio of 16.5 per cent of deposits that the PBOC imposes on China’s commercial banks has remained frozen since early last year and the money it has brought into the PBOC’s coffers has instead gone to “Other Depository Corporations”.

In other words, the PBOC has gone directly into the banking business with 8.6 trillion yuan of directed funding of commercial banks that need this support because their balance sheets carry the worst of the state-directed lending to state-owned corporations. No, this is indeed not a shrinking of the PBOC balance sheet. This is a trashing of that balance sheet. It is a good question whether the word “commercial” can really be applied to mainland banks when they are the confessed servants of state planning but there is certainly no commercial in it when their deposits are taken from them and then re-routed to them with instructions to throw good money after bad.

But the PBOC is a central bank and central banks cannot go bust. They can just create more money and pretend their mistakes never happened and that they never encouraged wasted effort. In this respect the Fed and the PBOC are exactly alike.

Which is why the talk of different policy tools makes no difference at all. One may dabble in government bonds to rig interest rates, the other in foreign exchange to rig exchange rates but they both believe in the free lunch and seek to promote growth through artificial stimulus. Well, maybe it really does work and maybe the ocean is dry and the desert is wet, but I don’t think so.