I have in a number of blog posts argued that China is a global or at least an Asian monetary superpower, which is exporting monetary tightening across Asia.

In a new very good blog post the former head of research at the OECD’s Development Centre Helmut Reisen discusses this hypothesis:

Usually, the current travails in emerging markets are blamed on expectations of slowing open market purchases by the US Federal Reserve System. Lars Christensen, head of emerging market research at Danske Bank, however, blames China´s monetary tightening as at least as important as the expected US Fed ´tapering´.  I have myself, with former colleagues, pointed to the growing impact that China´s growth has exerted since the last decade on GDP growth in middle- and low-income countries[1], pointing to the growing raw material, trade and production links of increasingly China centric emerging countries. So I shall have a lot of sympathy for Lars Christensen’s earlier proposition that China has also grown into a monetary superpower in a Sino monetary transmission mechanism with the rest of Asia. China´s monetary tightening, however, can hardly explain the current slump in Asian markets, on closer inspection.

So I nearly got Helmut convinced, but not quite. Here is Helmut again:

First, let us consider  the expected monetary stance in the US and in China. Graph 1 clearly shows that the market has formed expectations since May that the Fed would not continue open market purchases at the pace witnessed over the last years, partly fueled by Bernanke´s taper talk that month to US Congress. China´s monetary tightening, by contrast, occurred during late 2010 to early 2012 from when the Bank of China[2]. Since then, minimum reserve requirements were repeatedly reduced. Further, the PBC reduced its benchmark deposit and loan rates in June 2012. In addition, the PBC has also used a mix of monetary policy instruments to appropriately increase market liquidity. Even considering huge time lags, the current turmoil of Asia stock and bond markets cannot be blamed on China´s monetary tightening.

Hence, Helmut’s argument is that this is mostly caused by the Fed rather than by the People’s Bank of China. I do not disagree that the discussion of Fed tapering is having a negative impact on market sentiment in Asia. My view is just that that is not the whole story. China remains very important.

Furthermore, this is a good illustration of the Market Monetarist view of how to “measure” the monetary policy stance. While Helmut stresses that the PBoC has cut reserve requirements and interest rates recently Market Monetarists would instead focus on what markets are telling us about the monetary policy stance.

This discussion of course is similar to what happened in the euro zone and the US in 2008. Did the Fed ease or tighten monetary policy? Well, despite cutting nominal interest rates inflation expectations plummeted as did expectations for NGDP growth. That was indeed monetary tightening. And if we had good indicators for NGDP growth or inflation in China I would expect them to indicate a continued tightening of the Chinese monetary policy stance did the cut in official interest rates and reserve requirements.  The best market indicators for Chinese NGDP growth are probably copper and the Aussie dollar – and the Chinese stock market.

Hence, judging from for example the Chinese stock market monetary conditions have not become easier. Rather the opposite. And if the PBoC really had eased monetary conditions the Renminbi would have weakened significantly – it has not.

Furthermore, I would argue that communication about future changes in the money base is at least – in fact more – important than present changes to for example reserve requirements or interest rates. Hence, the communication from the Chinese authorities over the last couple of months has been decisively hawkish and if one wants to forecast the future path of the money base or the money supply in China one surely would have to conclude that the PBoC now plans a much slower rate of growth in the money supply than market participants had expected only a few months ago.

Furthermore, the PBoC’s rather clumsy handling of money market distress back in May-June left the impression that the Chinese authorities were quite happy about the impact it had on parts of the Chinese banking sector. In fact the turmoil gave reason to question that the PBoC really would act as lender-of-last-resort. That in my view was a very clear signal that the PBoC was quite happy with monetary conditions becoming tighter.

So yes, the PBoC has eased reserve requirements and cut official interest rates, but given the PBoC’s continued hawkish rhetoric market participants are not seeing the PBoC’s monetary policy stance becoming more accommodative – rather the opposite and judging from market pricing monetary contraction continues in China. That is having a clearly negative impact on the financial market sentiment across Asia.

That of course does not mean that Fed tapering is not important for what is going on in Asia at the moment. I think it is very important and it is for example clear that the sell-off in the Asian markets accelerated further this morning after the release yesterday of minutes from the latest FOMC meeting.

My point is just that the Fed is not the only monetary superpower in the world. The PBoC is also tremendously important. And on that I think Helmut and I are in total agreement.