Wielding China’s reserves

I have argued a number of times that the Chinese yuan could depreciate, against the consensus. Now, according to the Financial Times, Fan Jianping, chief economist of the State Information Center, thinks that yuan should be allowed to weaken:

Fan Jianping, chief economist of the State Information Center, a think-tank within the powerful state planning bureau, said that signs money was leaving China suggest now may be the time for the country to allow its currency to weaken. He added that a continuing fall in China’s foreign exchange reserves, which dropped $61bn to $3,202bn in September, would be evidence of the kind of capital outflows that should trigger depreciation.

Jianping is referring to what I observed in last month’s monetary statistics, that foreign exchange reserves fell in September.  If this is continues, I have reasoned that it could be a sign of capital outflow.

Within the framework of a currency peg (which China has a soft version of), foreign exchange reserve accumulation is an automatic response to persistent trade surplus and capital inflow (which are the consequence of the trade policy and capital control in the case of China), and the accumulation of foreign exchange reserve is accompanied by the issuance of currency, which makes the FX reserve accumulation in China essentially a quantitative easing programme.  If, however, foreign exchange reserves decrease, that means that PBOC and whoever running the FX reserve has to be selling FX reserve assets, and that selling is accompanied with a contraction of domestic Chinese yuan money supply.

Thus if China is to maintain a stable exchange rate against US dollar, a shrinking FX reserve will naturally tighten monetary policy.  Of course, China has some room to ease monetary policy with the peg still on, like reducing bank reserve requirement ratios to 0% or cutting rates but that’s all they can do without removing the peg.

Meanwhile,  Jin Liqun, the Chairman of China Investment Corp (i.e. China’s sovereign wealth fund), recently talked to Al Jazeera on how he looks at investing in the European Financial Stability Facility (EFSF):

Many of Liquin’s points are fair.  For instance, he considers investing in the EFSF to help the Eurozone essentially in the same way as investing in anything else. He operates under Chinese law as well as the law of the country he is thinking about investing in, and he tries to avoid investing in sensitive industries so that China acts only as a rational economic agent and avoids getting its hands dirty with politics.  Fair enough. Then he raised this point:

“You cannot come to me, asking me ‘Hey! Why don’t you pump money in this kind of… projects, or investing the banks that are in trouble… we are in trouble, and our two countries are friendly, so why don’t you come in?’, this is actually in stark contrast to the requirement imposed on our sovereign wealth fund”, “the recipient countries should treat sovereign wealth funds fairly… as any other financial investors…”

The host drilled on that further.  After some diplomatic gestures, Liqun said the troubles in European countries are:

“…the accumulated troubles of the welfare society… labour laws are outdated… incentive systems are totally out of whack… why should some [Eurozone] members’ people have to work until 65 or longer, whereas in some other countries they are happily retired at 55, languishing on the beach?  This is unfair… Chinese people are working very hard…”

So he thinks he can’t get a fair return bailing out Eurozone because some Europeans are lazy. He also hope to see emerging economies having more say on global affairs, which is also fair enough.

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