This is morning we got this news (from Bloomberg):
China’s central bank conducted the biggest reverse-repurchase operations since September, adding funds to the financial system after money-market rates surged and equities slumped.
The People’s Bank of China offered 130 billion yuan ($19.9 billion) of seven-day reverse repos on Tuesday at an interest rate of 2.25 percent. The monetary authority suspended the operations in the last auction window on Dec. 31, ending a six-month run of cash injections that helped drive borrowing costs lower in an economy estimated to grow at the slowest pace in more than two decades.
The People’s Bank of China (PBoC) continues to behave as if there is not Tinbergen constraint, but the PBoC soon has to realize it cannot continue to try to ease monetary conditions through liquidity injects into the money markets, lowering of reserve requirements and cutting interest rates, while at the same time trying to maintain an artificially strong Renminbi.
What the PBoC effectively is doing it trying to ease monetary policy with the one hand, while at the same time tightening monetary policy with the other hand by intervening in the currency market to prop up the Renminbi.
Instead it is about time that PBoC either let the Renminbi float completely freely (which effectively would cause a significant depreciation of RMB) or implement a large devaluation – for example 30% – so to avoid any speculation of further devaluations and then introduce a peg to a basket of currency as hinted in December.
The problem with the present policy is that everybody in the market realizes that this is what we will get eventually and that has caused an escalation of the currency outflow from China and this outflow is likely to continue until the PBoC bites the bullet and introduce a completely new monetary regime. This halfway house will not stand for long and if the PBoC keeps fighting it the central bank will just do even more harm to the Chinese economy and potentially also cause an major banking crisis.
PBoC is not alone in making this mistake and the Tyranny of the Status Que is strong within central banks around the world. Two good example are Kazakhstan and Azerbaijan. Both countries have in recent months given up the tighten link to the US Dollar and devalued their currencies significantly. This in my view has been the right decision as both of these oil exporting countries have been suffering significantly from the continued decline in oil prices.
But neither the Kazakhstani nor the Azerbaijani central banks (and governments) have introduce new rule based monetary policy regimes. So one can say they have left the Dollar peg, but forgot to finish the job. Therefore policy makers in both countries should now focus on what regime should replace the Dollar peg. I would recommend an Export Price Norm for both countries, where their currencies are pegged to a basket of the oil prices and the currencies of the countries’ main trading partners.
And China need to do the same thing – not introducing an Export Price Norm, but rather let the Renminbi float and then introduce an NGDP target or a nominal wage growth target and it need to do it very soon to avoid an escalation of the financial distress.
The PBoC has the power to end this crisis right now by floating the Renminbi, but the longer this decision is postponed the bigger the risk of something blowing up becomes.
PS notice that despite the sharp rise in tensions between Saudi Arabia and Iran oil prices are now lower than on at the close of trading last week. That to me is a pretty strong indication just how worried that markets are about China.
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