China’s surplus sinks

I missed this previously. The foreign exchange reserves of China fell in September compared to August, while remaining flat for the quarter.

While this is an expected outcome if the economy slows with the trade surplus narrowing and possibly less capital inflow (or even outflow), it is surprising to me that it is already happening in September.  Of course, this might be just a blip for the month as it was a very turbulent month, but it could be very interesting (and ominous) if this is not a blip.

Note that the accumulation of foreign exchange reserves is a consequence of the trade policy and partial capital controls which prevent the yuan from appreciating too quickly while at the same time allowing a persistent surplus and capital inflow. The increase of foreign exchange reserves is accomplished by the issuance of money, which is the key reason for the persistently excessive liquidity.  Thus, if the reverse happens (i.e. if FX reserves fall), the issuance of money could go into reverse, and that would introduce more tightening bias in monetary policy, even tighter than raising interest rates and/or reserve requirement ratios.

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