Chinese monetary policy failure

“Fed tapering” seems to be repeated in every single story in the financial media over the last couple of days. However, I am afraid that the financial media – as often is the case – is overly US centric. We might want to look at another central bank than the Fed. We should instead pay some (a lot!) of attention to the People’s Bank of China (PBoC).

This is from CNBC:

“China’s central bank continued to test the resilience of local lenders to withstand a cash crunch on Thursday, as money market rates soared once again and short-term rates hit record highs.

The seven-day repo rate, which is seen as gauge of confidence to lend in the interbank market, rose to a record high above 10 percent. China’s overnight repo rate jumped to as high as 30 percent, analysts said.

Chinese money markets have suffered a severe liquidity strain in the past week, due to seasonal factors and a sharp slowdown in foreign exchange inflows, raising concerns about the financial risks facing the world’s second largest economy.

But to the surprise of many market participants, the central bank has held back from pumping cash into the market to ease the credit squeeze and analysts said a spike in the rates at which banks lend money to each other was also a concern. “

I can’t help thinking that we have seen this before. The fed and ECB actions in 2008 come to mind.

This is what I said in my post “Dangerous bubbles fears” in October last year:

“…the PBoC eased monetary policy aggressively in 2009 and that pulled the Chinese economy out of the crisis very fast, but since 2010 the PBoC obviously has become fearful that it had created a bubble – which is probably did. To me Chinese monetary policy probably became excessively easy in early 2010 so it was right to scale back on monetary easing, but money supply growth has slowed very dramatically in the last two years and monetary policy now seem to have become excessively tight.”

It seems to me that the PBoC is just continuing the excessive tightening and that seems to be the real culprit behind the stream of bad economic data we have got out of China recently. It looks like Chinese monetary policy failure.

So yes, Bernanke might have a communication problem, but at the moment it seems like the biggest monetary policy failure is Chinese rather than American.

PS it seems like the Bank of Japan is regaining some credibility – the Nikkei has been remarkably resilient in recent days.

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  1. troopa

     /  June 21, 2013

    “I can’t help thinking that we have seen this before. The fed and ECB actions in 2008 come to mind.”

    I was thinking the same thing. Just hope they dont focus on money markets and banks as much as ECB and Fed, and miss the economy slipping into the black hole, because that could be a disaster for world economy.

  2. A shameless bit of self-promotion: Western and Middle Eastern history has been tied into the cycles of China since c.200 BC

  3. The interesting thing is that while we (and the media) all of the sudden noticed the credit crunch in China on Thursday morning, Chinese money market rates actually started rising on 15 May – about a week before the Nikkei began correcting.

    Then we had the headlines about the surging rates in China, and then the global sell-off.

    Yes, there was also Bernanke’s press conference. But I still find it hard to believe that he said anything new, or bad for that matter. He said only what we know already – that if the economy improves by as much as the Fed currently hopes, they will consider tapering. If it doesn’t, QE will continue as is, or even increase. I also found all the talk about the “loss of credibility” of the BOJ a bit strange, as you know.

    It seems to be that this whole correction might have been triggered by building up of the credit crunch in China. And when it finally made the headlines this week, the sell-off peaked. Today markets are rebounding. The Nikkei is actually up on the week.

    Could be a classic case of “sell the rumor, buy the fact”.

  4. “Chinese monetary policy probably became excessively easy in early 2010 so it was right to scale back on monetary easing, but money supply growth has slowed very dramatically in the last two years and monetary policy now seem to have become excessively tight.”

    Is monetary policy all that matters? What should the PBoC should have done instead?

  5. Benjamin Cole

     /  June 21, 2013

    I have been a fan of the PBoC, ever since I read a report from the Hong Kong Monetary Authority a few years back that the PBoC had a “revealed preference for growth.” I thought the PBoC’s 4 percent inflation target was better than a 2 percent target, if you have to have a inflation target.

    I am surprised at PBoC stinginess. Their stated inflation goal for 2013 was 3.5 percent, and they are well below that.

    What is it about central bankers? Sooner or later, they all become monetary ascetics—with attendant problems for whole populations.

    You know what is really nutso?

    Suppose you have “Plan X” for generating 5 percent real growth for five years, attended by 5 percent inflation.

    In other words, boom times. Fat City for businesses, workers, investors. National debt to GDP ratios would fall.

    As of now, the BoJ, the ECB and the Fed would say: “Oh no, we can’t go to Plan X. Inflation would be too high.” And now China too?

    Think about how nuts that is. Our central banks would thwart sustained robust growth, if accompanied by moderate inflation.

    And who says central bankers should not be voted in and out of office?

  6. I think China’s case is different.

    For starters, in the West and Japan, aggregate credit is broadly stagnant. In that context, it makes sense to print money, and create inflationary expectations.

    But in China, credit is growing by 20%-40% since 2008, but (nominal) GDP is growing by only 10% or so. The difference ends up in large part as a bad loan – i.e. money spent on gigantic infrastructure projects that don’t pay off. These projects generate no nominal GDP after they are completed. Worse still, they produce losses in the system on someone’s loan book. Adding more credit to that will not boost nominal GDP.

    In the West and Japan, monetary policy is about getting out or avoiding the liquidity trap. In China, there is no liquidity trap. Instead, there is excessive credit growth.

    And such a big gap between credit and income growth is not sustainable, it only adds bad loans to the system.

    The policy makers know this, and that’s why they are trying to bring down credit growth. But that’s very hard to do because of course it would also crush the economy.

    I don’t know how this can be solved. My guess is that China could try to hold out, and buy time, until the rest of the world recovers. Then it could use exports and income from foreign assets to balance the necessary domestic slowdown. The big question is whether it could do it without devaluing.

    It is a flaw in the development model. It worked well when the West was (over) consuming. But now it’s difficult.

  1. PBoC governor Zhou Xiaochuan should give Jeff Frankel a call (he is welcome to call me as well) | The Market Monetarist

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