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December 11, 2006
Chinese open market operations
Kash points us to an interesting tidbit in the Wall Street Journal:
SHANGHAI -- China's central bank said it plans to absorb about $20 billion in cash in its latest effort to keep its economy from overheating. The move is meant to rein in lending without raising interest rates and to reduce liquidity in the country's financial system.
The People's Bank of China said Friday it plans to sell banks about 160 billion yuan, or $20.45 billion, of one-year bills in the yuan money markets today. The bills will yield 2.7961%. By placing the debt instruments with commercial banks, Beijing is reducing the amount of money banks have available to lend.
Kash's take:
...a bond issue of this size indicates that the financial pressure may be building on the PBOC to use the next obvious tool that would reduce the amount of yuan floating around in the Chinese economy: to allow the yuan to appreciate faster against the US dollar.
I agree with Kash. In the past, the Chinese were able to conduct operations like this behind the wall of capital controls. The capital controls allowed them to fix their exchange rate AND pursue independent monetary policy goals. Without capital controls (i.e. with a convertible currency), fixing your exchange rate to the dollar means subordinating your monetary policy to the U.S.. While that wall of capital controls has not entirely crumbled, it has been breached. For example, there was this announcement in July 2005 which was followed by a revaluation just a few days later. Unless these massive currency flows (caused by China's rapidly growing export sector) are sterilized, inflation is sure to follow. Higher interest rates are one possible approach, but given the fragility of the banking sector, it is not a particularly welcome prospect. Currency appreciation (or even revaluation) is another. Most likely, they will need both.
As always, the trick is to pull this off without causing a speculative run. Since the yuan is moving against the dollar, and the rate of appreciation appears to be picking up, they probably see things as moving more-or-less on course.
If they decide to move faster, it will be to try to quell their own inflation threat, not to respond to certain U.S. senators.
UPDATE: It is worth remembering that Secretary Paulson and Chairman Bernanke will be visiting China in a couple days. I'm guessing that these developments will be on the agenda at some point.
Posted by William Polley at December 11, 2006 4:35 PM
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