More On Yuan Depreciation, China's Great Depression

One chart to show why China should worry about Fed tapering too
Why should China worry if Renminbi is under depreciation pressure again?

FX inflow and outflow have tremendous impact on China's domestic monetary policy. When capital flows into China, in order to keep Renminbi exchange rate stable, the PBOC is forced to inject more liquidity into the banking system. Although someone may argue that the PBOC has issued bills and raised reserves to avoid excess liquidity injection, it does not seem to be the case. There are two problems here. First, the net bill issuance and reserve raising has never been enough to sterilize the capital inflow in recent years. Sun Guofeng, the deputy-head of PBOC's monetary policy department, said in his book that FX inflow can explain 25% of the deposit creation in China in the past decade. Second, PBOC bill itself is a quasi-money instrument as it is very liquid and people can use the bill as collateral to borrow so it is pretty hard to argue that issuing PBOC bills can effectively sterilize the excess liquidity.

When capital flows out of China, as we saw from 4Q2011 to 3Q2012, domestic liquidity creation and monetary expansion would be much slower. Of course the PBOC can inject liquidity by cutting reserve requirement ratio or doing reverse-repos, but the problem is that China has enjoyed excess liquidity for so long that even if liquidity situation goes back to normal China would feel thirsty. If the central bank failed to be proactive, liquidity situation could only go worse. Moreover, what we are seeing this year is that very fast credit expansion led to pretty low GDP growth (by China standard), so what would happen to economic growth if credit expansion slows down?
Normal is a crisis for China. If China swings into crisis levels faced by normal economies, it will be China's Great Depression.

For a less dire forecast and a very detailed look at what's going on in China: All About the Maos: Charting China’s Cash Crunch
Is this Lehman with Chinese characteristics? The answer is no. The central bank has vast resources at its disposal to prevent a downward spiral. But it does highlight increasing stress in China’s financial sector, as growth in the real economy pushes toward a 20-year low.

....The current squeeze suggests that events may have run outside the central bank’s control. Seven-day borrowing rates touched 28% in trading Thursday, a record high. That sparked rumors in the market of everything from a default by a major bank to a secret injection of liquidity by the PBOC (later denied by the banks).
This sentence is important because many people believe the Chinese are better able to control their economy because they have more control over their economy. These people give too much credit to the Federal Reserve, but they give even more to the PBOC, when neither has any real power to control the economy. They can act within it and nudge it easily when the economy is running smoothly, but research has shown the central banks track interest rate changes in the economy, moving short term rates up and down after the bond market has made the move. When things breakdown, the crisis will happen entirely out of the central bank's control. Therefore, assuming the bank can control it is the wrong way to think about a crisis, though it is a valid argument for why there may be no crisis now.

In my opinion, this crisis is more serious because the anecdotal evidence reached street level. Not two or three weeks before the cash crunch began, the microfinance and credit companies selling trust products started advertising on the street, pushing their products next to the real estate agents. I've probably seen them before, but this time they were out everyday, something I have not seen before.

No comments:

Post a Comment