Initial Thoughts on PBOC Easing

Last night, the PBOC (China’s central bank) lowered the reserve requirement ratio (RRR) for Chinese banks by 50 basis points, down to 21% for large banks, freeing up an estimated RMB 400 billion ($63 billion) in new lending.  Here are my initial thoughts on why they did it, and what it means:

• The move is being described as a “surprise,” mainly because the PBOC and several top leaders (including Premier Wen Jiabao) have spent the last month adamantly asserting that China was committed to its policy of continued tightening, in order to rein in inflation and asset bubbles.  However, the reason such repeated denials were necessary was that the PBOC clearly was coming under immense pressure to loosen:  (a) the NDRC and other influential ministries have been calling for loosening since the summer, (b) local governments have been warning that, without more generous lending, they would not be able to make enough investments to achieve their GDP targets for 2012, and (c) overextended property developers were running out of the credit needed to continue financing their unsold inventories, which they had begun dumping onto the market — such pressures were already leading to business failures in especially exposed locales like Wenzhou and Ordos, where the policy response had been to loosen (on a local basis) and throw endangered parties a credit lifeline.  As I’ve said many times, the problem is that China wants a correction without  having a correction — so it’s no surprise that the monetary authorities have been  forced to back off when the pain of adjustment started to be felt.  (One-time Fed Chairman William Mcchesney Martin famously observed that the job of a central banker is to “take away the punch bowl just when the party is getting started.”  To put it simply, the PBOC just handed back the punch bowl.)
• Markets are sure to hail the PBOC’s move as a sign that a “soft landing” has been (or is being) successfully achieved.  They would be mistaken.  The PBOC resisted loosening because it fears — and I agree with them — that pumping more money into the economy will reignite inflation and reinflate the property bubble.  The conventional storyline goes that China is loosening into order to offset weakening export demand from Europe.  I think it’s more accurate to say that Chinese leaders were hoping that vibrant export demand would offset the need for a more substantive adjustment within the Chinese economy, and that hasn’t materialized.  So their sole — and highly problematic — alternative is to try to reflate China’s investment boom through monetary easing.  The PBOC, and China’s more perceptive leaders, know this is not a sustainable solution, but they’re stuck.  My guess is that this is what Chinese Vice Premier Wang Qishan meant when he recently told U.S. trade negotiators that “an unbalanced recovery is better than a balanced recession.”
• There is some reason to believe the PBOC may have felt it had some wiggle room to lower the RRR.  Remember that the main thing driving up China’s domestic deposit base — and therefore its money supply — has been the inflow of foreign currency from its current and capital account surpluses, combined with official reserve purchased by the PBOC to keep the Renminbi from appreciating.  When the PBOC stopped sterilizing this inflow at the end of 2008, the money supply exploded, financing China’s lending and investment boom.  The PBOC’s repeated hikes to the RRR, starting in late 2010, were really just a return to sterilization (they were successful in bringing M2 and formal lending under control, but not so successful in preventing massive credit expansion in the form of “shadow lending.”)  In recent months, though, weakening export demand has reduced China’s current account surplus, while fears of a “hard landing” — particularly in real estate — appears to be causing some money to flee China via the capital account.  In October, China’s FX reserve holdings actually declined by RMB 25 billion, for the first time since 2008, and we’ve seen some downward pressure on the RMB-USD exchange rate.  For the time being, at least, that relieves the PBOC of the need to sterilize additional FX purchases via continued RRR hikes, and gives them some policy leeway which they didn’t previously enjoy.  That being said, actually lowering the RRR (and freeing up RMB 400 billion in funds for lending) still signifies a net loosening.
• Finally, I found it interesting that the PBOC lowered the RRR by 50 basis points on the same day that the Fed announced a coordinated effort with five other central banks (England, EU, Japan, Canada, and Switzerland) to provide additional liquidity to global markets by lower pricing on U.S. dollar liquidity swap arrangements by 50 basis points.  Perhaps it’s just a coincidence, but seeing the word “coordinated” makes me wonder whether the PBOC coordinated its move — and particularly the timing of that move — with the other central banks.  Of course, the liquidity issues China is experiencing in its own domestic credit crunch are entirely different — both in origin and implication — from what’s going on in Europe:  China stands at the peak of a bubble, while Europe and the U.S. stand in the trough of a recession.  But “running with the pack” — participating in a kind of coordinated global relief effort — does offer the PBOC some intellectual cover for its capitulation to China’s go-go growth lobby (in other words, handing back that punch bowl).