The lesson should be changing reserve requirements for a non convertibility currency, as the yuan is domestically for all practical purposes, doesn’t alter liquidity, but does alter balance sheet composition and pricing necessary to hit return on equity targets.

And looks to me more like their stealth inflation problem hinted at previously hasn’t yet been reigned in to their satisfaction?

  • 50bp hike in RRR for six large banks, valid for two months
  • the unusual temporary move reflects the central bank (PBoC)’s concern over strong lending appetite and hot money inflow
  • the PBoC is likely to follow up with more measures based the effectiveness of current policy
  • a lesson to the developed country on how difficult it is to rein in excessive liquidity

According to Reuters, China has raised reserve requirements by 50 basis points for six large commercial banks to 17.5%. It is reported that the move is only temporary and will be in place for two months. However there is no official statement from the central bank yet.

These six banks account for around 40% of China’s total lending and nearly 50% of the total bank assets. The 50bp hike in reserve requirement ratios will lock up about CNY150 bn of deposits.

We think the unusual temporary measure reflects the PBoC’s concern over excessive liquidity in the domestic economy on the backdrop of a robust growth. The total banking lending from January to August has reached 76% of the full-year target (CNY7.5 trillion), which means the monthly lending needs to be below CNY450 bn. However the domestic credit demand still seems to be very strong. Another possible reason for this move is the mounting evidence that the hot money is flowing back due the increasing pressure on the yuan appreciation.

The PBoC move speaks of the problems in managing a generous liquidity policy and stands as both a warning and a contrast to those other central banks considering a further round of quantitative easing. Once a generous liquidity policy is in place, it becomes difficult to wean dependent companies off the cheap and easy liquidity flow. Whereas the PBoC is not “pushing on a string” and there is genuine demand for this liquidity, the warning to the US federal reserve is clear. Even for economically well-administered economies, the latter stages of generous liquidity policies become very difficult to manage. Zombie (cheap liquidity dependent) companies, potential asset bubbles and the intractability excess liquidity are all legacy issues central banks
considering QE2 must consider.

Except that those are not the result of QE, but of what is functionally fiscal support for zombies, and the only effect zombies have on the real economy is that they waste valuable labor hours. Unfortunately no one seems to know how to keep fiscal drag low enough to sustain full employment so they see political benefit to useless employment.

3 Responses

  1. “but does alter balance sheet composition and pricing necessary to hit return on equity targets”

    That’s rarely seen but exactly right. I wonder if anybody outside MMT knows it?

  2. Thanks for post. I was wondering if someone could add some more info on the “stealth inflation problem.” Do you mean the inflation in asset prices or something else?

    I live in Shanghai and I am constantly trying to reconcile the seemingly robust growth I see on the ground with the dire predictions of some analysts. I think MMT is the missing ingredient in this analysis but I can’t wrap my mind around how.

    How might asset prices transform into an increase in the CPI? What is the end point to the current investment boom? Where is the inflation that a rapid increase in the money supply implies?

    1. it’s all about aggregate demand and spending power. govt can sustain that with simple fiscal adjustments (including adjustments in state lending). The political problems come in when demand starts driving up prices in general.

      The channel from asset prices is lending against those assets. Loans create deposits and spending power.

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