PBoC should stop the silliness and float the RMB

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.

—-

If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

A horrible start to the year

It has been a horrible start to the year – a sharp escalation of geopolitical tensions between Iran and Saudi Arabia have sent shock waves through the global stock markets today. In China trading was suspended as stocks fell 7% and we have also seen sharp sell-offs in the European stock markets today.

To makes things worse the latest news for the US economy is far from uplifting. Hence, ISM for December fell to 48.2 from 48.6 in November indicating a contraction in the US manufactoring sector.

My good friend Michael Darda – Chief Economist at MKM Partners – makes this interesting observation:

The ISM Manufacturing Index came in at 48.2 in December, the second consecutive month of contraction. The ISM New Orders Index also came in below 50 for the second consecutive month, suggesting ongoing weakness in S&P earnings growth and capital spending trends. Although it is not unusual for the ISM Index to fall below the 50 threshold during an economic expansion, it is unusual for the Fed to hike rates/tighten monetary policy with the ISM Index below 50. Going back to 1948, we count only six instances when the Fed hiked rates with the ISM Index below 50: five of those episodes were associated with a recession occurring between one and six months later.

So is the US facing a recession? I don’t know, but if the Federal Reserve insists on continuing to hike interest rates through 2016 and if we on top of that get a negative supply shock in the form of rising oil prices on the back rising geopolitical tensions in the Middle East then I certainly would think that we could move close to a US recession in 2016.

But that need not to happen if the Federal Reserve acknowledges that US monetary conditions are already tight rather than easy and hopefully cooler heads will also prevail in the Middle East.

%d bloggers like this: