Y.I GANG, THE The head of the Chinese central bank likes to say that he wants to pursue a “normal” monetary policy. By this he means keeping interest rates well above zero, ensuring that the yield curve slopes upwards, and avoiding direct purchases of government bonds – a large part of which actually make up the People’s Bank of China (PBÖC.) a very abnormal central bank these days. The clearest sign of this is the balance sheet. In terms of wealth, the PBÖC. has developed from the undisputed heavyweight to the middleweight. His reluctance is a combination of two different aspects of the pursuit of political normalcy: avoiding unusual maneuvers that have become common elsewhere and reversing some unusual maneuvers that were previously common in China.
From the early 2000s, the PBÖC. accumulated assets at an amazing rate, almost entirely in the form of foreign exchange reserves. The build-up was the result of his policy of limiting the yuan’s appreciation at a time when China was running a huge trade surplus. The PBÖC.Wealth peaked at 70% GDP In 2008 more than twice as high as in America, Europe and Japan at that time. As China’s foreign exchange reserves have shrunk in the past five years and then stabilized, the central bank’s balance sheet has also stabilized.
In contrast, the assets of the Federal Reserve, the European Central Bank, and the Bank of Japan have largely risen over the past decade as they have implemented quantitative easing, bought government bonds, and in some cases corporate stocks and shares. To minimize the economic damage caused by the coronavirus pandemic, they are buying even more bonds. The PBÖC.however, hardly contributed to his wealth (see chart). As a part of GDPThe size of the balance sheet is now roughly equivalent to that of the Fed – around 35%.
In part, China’s reluctance is due to the fact that the economy is in relatively better shape, the virus has all but stopped, and growth is recovering well. In part, it also reflects what might be called the Kipling Doctrine in China’s drive to promote the yuan’s international role: if you can keep your money supply in check, when everything around you is expanding like crazy, status might a reserve currency will one day belong to you.
However, there is also a deeper reason for China’s apparent conservatism. It is gradually reversing some of its extraordinary interventions in the past. In order to maintain an undervalued currency, the PBÖC. printed as much yuan as needed to buy the foreign currency flowing into China. In order to prevent the newly created money from causing inflation, it had to suck up much of it again or “sterilize” the inflows. This was mainly done by increasing the reserve requirements for commercial banks. At the height of 2011, banks had to deposit 21.5% of their deposits with the central bank. After repeated cuts, including two since the coronavirus outbreak, medium-sized banks only have to set aside 9.5% of their deposits in order to be able to issue more loans. Coupled with targeted cash injections and old-fashioned moral persuasion (a powerful tool in a largely state financial system), the PBÖC. can support the economy without dramatically increasing its balance sheet.
However, the stability of this balance sheet has raised questions about whether it is possibly cleverly accumulating foreign exchange reserves. The main reason for suspicion is that China’s reserves have barely moved despite China’s huge trade surpluses ($ 62 billion in July, just below a monthly record in May). However, a focus on trading overlooks the money left over through other channels. In the second quarter, net cash outflows (excluding direct investment) rose to $ 104 billion – two-thirds of trade gains – in part due to mainland Hong Kong poking around stocks. This suggests another way in which the monetary system looks more normal: It becomes devilishly complex to monitor all cash that crosses China’s borders as it gradually opens its capital account. ■
This article appeared in the Finance & Economics section of the print edition under the heading “Conformity with Standards”.