My Blog

September 25, 2007

Sorry, but for the past two days for some reason neither I nor anyone else, it seems, can access my blog from within mainland China.  For this reason I have not been able to write anything until some kind friends explained to me how to get around these censorship things (I am sort of an idiot with internet technology).  I am now using a proxy, but there have nonetheless been some difficulties so that I am unable to respond directly to comments.

I wanted nonetheless to respond to an interesting comment by “Max”, so I figured one way might be to post the comment, and my response, as a regular entry.  Here it is: 

I am not sure I understand why you think that Central Bank Bills are ineffective as a sterlization tool. or why being very liquid makes them ineffective? For arguments sake let's ignore the fact that they try and sell these bills at artificially low rates as I do agree that would cause a problem but only to the extent you can't sell enough to sterlize the amounts you want. If the PBOC sells anything, it contracts the money supply. That is the role of any central bank's balance sheet. The PBOC sells a bill, the asset side of the ledger goes down therefore its net reserve liabilities must go down too. Assuming the bank that bought the bill did not have excess reserves at the central bank then he had to sell some other asset in order to get the money to pay for the central bank bill. You say that these Central bank bills are too similar to cash. What does that mean? Do these bills qualify as reserve instruments? If so, then of course it doesn't work, but that is not sterilization.

On the CIC. Can you clarify exactly what is happening here. It sounds like they have created away for the PBOC to reduce reserves; unsterilized. The government is raising RMB in the marketplace by selling these 10 year CIC bonds. The government then sells the RMB to the PBOC for FX . So the PBOC gets to reduce its FX reserves and see RMB taken out of the market. The FX reserves sold to the Governement is now effectively owned by the new owners of the CIC bonds. These new owners of the CIC bonds have effectively sold RMB and purchased ownership of FX reserves or FX reserve collateral against payment. How much do the new CIC bonds pay anyway?Are they getting above market rates? Bleow market rates? 

Max, I will do a bigger posting on this later, but to be brief I am a Mundellian on the subject of money.  Increasing the liquidity of assets is analogous to increasing the money supply, and some assets are so money-like that exchanging them for money has little impact on overall liquidity conditions.  Central bank bills in China can be used as reserves and can be purchased by corporations who need to park short-term cash.  There is little differnce between them and cash in a checking account.  At any rate the proof of the pudding is in the eating, and it is hard to argue that China does not look like a country that is seeing rapid, unsterilized monetary expansion.  The PBoC also seems to be stretching for longer term assets to sell to soak up liquidity, although this policy is constrained by their reluctance to see rates rise too much.

As for the CIC, here is how I think it will work.  The MoF sells bonds to a local bank, and passes the proceeds on to the CIC as equity.  The CIC uses the cash to purchase dollars from the PBoC.  After a decent interval, the PBoC uses the cash to purchase the MoF bonds from the local bank.

Now, the net result is that the PBoC has exchanged dollars for MoF RMB bonds.  Nothing has happened to the local money supply.  However, as bills come due, the PBoC, rather than rolling them over, sells the MoF bonds to raise cash to repay the bills.  The net effect is that PBoC bills held by the market have been exchanged for MoF bonds.  Does this make sense?

Comments (3) for "My blog is blocked"

Congrats, Mike! it shows ur blog is at least worth reading... By Ali - 9/25/2007 8:41 PM

Michael, on sterilization. I agree. The proof is in the pudding. China is certainly not sterlizing enough of the FX purchases. I am not an expert on this but, if you can use the Central bank bills AS reserves then how can selling or buying these Bills even be considered sterilization? If bank ABC has xx amount of reserves required to be held at the PBOC and then the PBOC says let me change some of your exisiting reserves into these bills and you will still meet your reserve requirements, then they have done nothing to soak up the newly delivered RMB from FX transactions. Sterlization requires the buyer of the Bill to use his reserves to purchase the bill and then sell something else to raise money to meet his diminished balance of reserves. Thus the Central bank has forced the market to find RMB to buy these bills. Since they just gave the market some RMB with an FX transaction, sterilization is achieved! So I guess to sum up. it is no wonder that the PBOC has failed in its sterlization attempts, it allows the banks to treat the sterilization instrument as reserves itself. The bank that sold USD to the PBOC is free to use the RMB recieved to buy other stuff. It can use existing reserves to buy the sterlization instrument. On the CIC....I did not know of the last leg where the PBOC buys the CIC bonds from the market place. Thanks for clarifying that. Perhaps they are missing an opportunity to do some real sterilzation here. Why do the last leg? In fact, why sell CIC bonds? they should sell CIC shares and NOT buy them back from the market. They can socialize the coming losses on USD depreciation more narrowly. Instead of having the general taxpayer take a hit when the USD weakens, they can direct it at people who buy CIC shares? And the loss might not be as great since the CIC will be aiming at better retruns and more diversifcation than the PBOC. By Max - 9/26/2007 12:52 AM

Michael -- I agree with Max that if Central Bank bills could serve as required reserves, the whole purpose of selling CB bills for sterilization would be defeated. But I question your premise and cite the PBOC's Monetary Policy Report, Quarter Two, 2007, p. 6: "The rapid growth of base money was caused mainly by several hikes in the reserve requirement ratios since the second half of 2006, as according to the current statistical coverage, required reserves are included in the base money but central bank bills are not." The report elaborates that when liquidity is restrained by the sale of CB bills, base money growth is slower than when liquidity is restrained by an increase in the reserve requirement. The link to the monetary policy report is here: http://www.pbc.gov.cn/english//detail.asp?col=6618&ID=38 By Calla - 9/26/2007 12:24 PM