China cuts reserve requirements: is it too late?

This graph comes from a BIS working paper: China’s evolving reserve requirements. I highlighted an important portion from the abstract as it relates to the cut in the reserve requirement:

This paper examines the evolving role of reserve requirements as a policy tool in China. Since 2007, the Chinese central bank (PBC) has relied more on this tool to withdraw domestic liquidity surpluses, as a cheaper substitute for open-market operation instruments in this period of rapid FX accumulation. China’s reserve requirement system has also become more complex and been used to address a range of other policy objectives, not least being macroeconomic management, financial stability and credit policy. The preference for using reserve requirements reflects the size of China’s FX sterilisation task and the associated cost considerations, a quantity-oriented monetary policy framework challenged to reconcile policy dilemmas and tactical considerations. The PBC often finds it easier to reach consensus over reserve requirement decisions than interest rate decisions and enjoys greater discretion in applying this tool. The monetary effects of reserve requirements need to be explored in conjunction with other policy actions and not in isolation. Depending on the policy mix, higher reserve requirements tend to signal a tightening bias, to squeeze excess reserves of banks, to push market interest rates higher, and to help widen net interest spreads, thus tightening domestic monetary conditions. There are, however, costs to using this policy tool, as it imposes a tax burden on Chinese banks that in turn appear to have passed a significant portion of this cost onto their customers, mostly depositors and SMEs. However, the pass-through onto bank customers appears to be partial

Consider the highlighted sentence in light of the following articles, all from the previous week:

FDI drops over EU debt crisis

Foreign direct investment dropped for the third straight month in January as European investment plunged by 42 percent from a year earlier. The slump in European investment was instrumental in causing a slight fall of 0.3 percent in FDI.

The drop prompted a warning from the Ministry of Commerce over the "grim" outlook for FDI.

China's Forex reserves likely to decline this year: Report

Chinese forex reserves will continue to decrease in 2012, Lian Ping, chief economist at Chinese Bank of Communications, said.

China's economy is no longer as heating as in the past, and that is the main reason among others why Chinese exchange reserves are dwindling, he said.

Chinese Banks’ Bad Loans Rise in Fourth Quarter as Economy Slows

Non-performing loans rose 20.1 billion yuan ($3.2 billion) to 427.9 billion yuan as of Dec. 31, the China Banking Regulatory Commission said in a report on its website today. Bad loans accounted for 0.96 percent of total lending, up from 0.95 percent in September and 0.17 percentage point lower than a year earlier.

In China aims for 14% M2 growth; M2 growth hit 17% in December, I showed money supply growth is still in a multi-year downtrend, but remains in the high double digits. I discussed China's dilemma in a December 2010 post, Larry Meyer echoes Liu Junluo:

For many countries, it may be too late, particularly in the case of China. They should have started moving away from exports years ago and let their currency appreciate more rapidly, and now they are caught in a bind. If they do not allow the currency to appreciate, inflation may quickly surge into the double digits. Once that happens, they must take drastic action, but even if they act to stop the inflation, it may be too late to prevent a deflationary bust in the real estate market (especially in China) or other asset markets.

Federal Reserve policy is likely to create a crack-up inflationary boom that leads to another Asian Crisis and the actions taken by Asian governments and central banks will also lead to deflation.

China's policy mistake, if a major crisis erupts, was to delay restructuring. Without a positive shock to the economy, the government and central bank are caught between the Scylla and Charybdis of major inflation or deflation. In order to stop inflation generated by the Fed's QE policies and slow the internally fueled real estate bubble, the PBOC tightened and the central government clamped down on real estate. Deflation is now settling in. The big question is how bad is the real estate slowdown? If the optimists are right, the sector will stabilize in the second half and central bank easing will help spur growth to offset negative shocks. If it's bad, the PBOC is behind the curve and more serious deflation will follow. Then the money spigots will open and we'll really see some inflation accompanied by currency depreciation (unlike the brief dip in late 2011). Then we may see a China gold frenzy that puts the past two years to shame.

On the subject of hyperinflation, in September 2011, I posted Liu Jun Luo: Six to ten months until Chinese hyperinflation. Liu argued for a policy of wage inflation, using the war analogy of taking losses to slow the enemy. By raising wages and accelerating domestic inflation, the government would kill the export sector but support the rest of the economy—and crucially protect the exchange rate. Otherwise, Liu argued negative economic shocks from Europe and the U.S. would lead to serious deflation and then money printing, which would cause hyperinflation fueled by exchange rate collapse.

Liu has been talking about hyperinflation for awhile. He targeted 2012-2013 as the years for hyperinflation in China. This post of his is from March 2010:2012年——2013年中国恶性通货膨胀. He also expected (still expects) a gold market crash: Liu Junluo: Gold crash coming. He saw a gold bubble in China, but it has only grown much larger in 2012. If he's right about hyperinflation, gold may do well priced in yuan, but the decline in global growth would be deflationary. Commodity exporting nations and commodities would be hit hard, taking gold with them at least temporarily (similar to 2008). During this period, Chinese may prefer dollars to gold, an action that would lead to the type of currency collapse he predicts.

Liu Jun Luo: Six to ten months until Chinese hyperinflation

Liu Jun Luo has a new blog post up. He's notorious for not laying out all the details, so I will set this up a bit. The following is my interpretation of what he's writing, filling in some spaces. You can read his writing below in Chinese or English. The Chinese economy is unbalanced with far, far too much investment directed by government owned companies or government bureaucrats. Government investment is often negative in and of itself (relative to a similar private investment) since it tends to be less efficient, and while there were good infrastructure projects before, a lot of the recent spending only fueled real estate. China desperately needs to rebalance as fast as possible, and one way to do that is to create wage inflation. In this article Liu Jun Luo talks about how on a battlefield, you destroy some areas to slow the enemy. There's a depression in the West that's about to become more severe, exports are going to drop and Chinese will become unemployed. Defending this sector of the economy makes no sense. The bigger threat is that deflation takes hold in China because of the credit bubble. When investment bubbles in Asia burst, it's the currency that gets annihilated. Mr. Liu's advice is that China create the inflation itself, rather than suffer the "super" inflation that will result from a currency collapse that will wipe out stocks, real estate and the savings of ordinary Chinese. 回复刘军洛新浪微博粉丝提问

正确的预期是非常重要的，目前全球债务膨胀，美国、德国、英国的长期债券收益率全部下降的创记录低点，这已经说明全球大量私人资本正在大规模退出劳动力市场和资本市场。

中国目前的通货膨胀现象是一个严重的假现象，这就好像2008年3月份中国通货膨胀达到当时的高峰，结果，在2008年9月份的世界外部冲击打进了大萧条。

所以，目前正确的方式是中国中央银行要制造通货膨胀，就是大幅度提高工资。因为，如果我们再被外部像2008年9月份打进了大萧条，那么，中国将用6~10个月时间演变成真正的超级通货膨胀。这是，人民币汇率崩盘的通货膨胀，那么，这就是不可救药失控的通货膨胀。

目前，如果我们大幅度提高工资后的通货膨胀是不会危害的汇率的，但是，我们错误的选择了大萧条，那么，人民币汇率就必定崩盘。
这就好像战场，你必须选择局部地区的大量牺牲，因为，这也意味着大量敌人被你也严重拖延在局部地区。中国现在最失败的地方就是没有居民免费食品券机制。

你需要明白我们实际是在谈论人民币汇率问题。中国大萧条后演变的超级通货膨胀是迅速消灭所有人的股市资产、房地产资产和储蓄资产。

现在，中国的宏观层面无法理解我们真正问题是人民币汇率上面，所以，中国普通人只能自保，因为，这是一场中国普通人的人生灾难。

同时，世界的套利者也把这个事件看的清清楚楚，他们会顺应市场的趋势，把这场大规模的灾难变成更大数量级的灾难。

Below is the Google translation, which I touched up a bit.

Correct expectations is very important, the current expansion of global debt, the United States, Germany, the UK's long-term bond yields fell to a record low point, which has indicated that a large amount of private global capital is a large-scale withdrawal from the labor market and capital market.

China's current appearance of inflation is a serious false appearance, similar to China in March 2008 when inflation reached a peak as a result, in September 2008 global external shocks turned into the Great Depression.

So, now the proper way to create inflation is for China's central bank to substantially increase in wages. Because, outside shocks similar to September 2008 again bring the Great Depression, then, in 6 to 10 months China will evolve into a real super-inflation. This is the collapse of the RMB exchange rate inflation, then, this is hopelessly out of control inflation.

Currently, if we significantly increase wage inflation it is not harmful to the exchange rate, but we wrongly choose the Great Depression, then, the RMB exchange rate will collapse. It's like the battlefield, you must choose to sacrifice a large number of local areas, because this also means that a large number of enemies are seriously delayed in some areas. China most failed area now is that there are no food stamps.

You need to understand that we are actually talking about the RMB exchange rate issue. After China's Great Depression, the evolution of super-inflation will mean the rapid annihilation of all stock market assets, real estate assets and savings assets.

Now, China's macro level cannot understand our real problem is that of the RMB exchange rate, so all the Chinese ordinary people can do is protect themselves, because this is a catastrophe for the lives of ordinary Chinese.

Meanwhile, the world arbitrageurs also clearly see this event, they will follow the market trend, the large-scale disaster of this magnitude will become an even greater disaster.

Liu Junluo: We have already entered the economic depression

This is a short post from Liu Junluo, he's been busy writing a book. I'm not sure how much this squares with Prechter and the other deflationists, but this is close to my own view, that first we have deflation and then inflation. Marc Faber has been more inflationist in his arguments, but he has said he holds that position because if the market or economy have a severe decline, the response will be money printing.

世界已快进入了真正的大萧条期

本人今年3月14日在北京讲课时，是谈今年底美元指数会站在85，年内很可能上冲90，当时也指出这是非常非常保守的估算。现在，故事已进入秦国统一战争的最后时刻，这个时刻对秦国是万马平川、轻松自如。所以，美元是不是会走出让全世界人与全体中国人都一辈子也看不懂的宏大行情呢！请你设想一下，当秦国最后统一六国的那个时刻，是怎么样的暴风骤雨。黄金现在与美元同步上涨，是世界上有几个人用黄金创新高来鼓励全体中国人相信“通货膨胀”快来了，是掩盖美元即将爆发的真正的壮观行情。这个时代是伟大与贫富严重分化的时代。今天的保存，才会有明天的生长。相信“通货膨胀”的中国人都快要死了。本人再说一遍，中国是先“恶性通货紧缩”，再“恶性通货膨胀”，美国人现在要把中国市场防“通货膨胀”的人，先用“通货紧缩”吊死，而后再使中国爆发“通货膨胀”。

My synopsis: Liu Junluo says that at a March 14 lecture in Beijing, he said the U.S. Dollar Index would be at 85 by the end of the year, maybe 90, but this was his conservative estimate. He says the U.S. dollar is about to make its greatest move in our lifetimes. He compares the current situation to that of state of Qin, which conquered the other six states to unify China in the Warring States period, that this was a very violent period. He says that gold and the U.S. dollar rising together is seen as a sign of coming inflation by most people, but that in fact it conceals the U.S. dollar's spectacular move. He says that today's savings are tomorrow's growth and that those Chinese who believe in inflation will soon want to die. He reiterate that first their will be horrible deflation, and that will be followed by hyperinflation.