For a number of times, you have read here that if the Chinese economy faces a hard landing (which is still judged to be likely, never mind some occasional better-than-expected blips), Chinese Yuan could depreciate (yes, you’ve read that correctly, see here, and here). That is because monetary policy can’t be eased infinitely within a monetary system with a currency peg in place.
Even though we are still far from the endgame in my worst case scenario, surprisingly one bloke close to government is talking my book, which is somewhat at odds with not only the market consensus, but also government officials. According to Financial Times, Fan Jianping, chief economist of the State Information centre, thinks that Yuan should be allowed to weakened:
Fan Jianping, chief economist of the State Information centre, 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.
He, of course, is referring to what I have observed in last month’s monetary statistics that the foreign exchange reserves actually shrank in September. If this is to continues, I have reasoned that it could be a sign of capital outflow.
Within the framework of currency peg (which China has a rather soft one), 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 issuance of currencies, which makes the FX reserve accumulation in China essentially a quantitative easing programme. If, however, foreign exchange reserve decreases, that means that PBOC and whoever running the FX reserve has to be selling of FX reserve assets, and that selling is accompanied with contraction of domestic Chinese Yuan money supply.
Thus if China is to maintain stable exchange rate against US dollar under, shrinking FX reserve would naturally tighten monetary policy. Of course, China has some room to easing monetary policy with the peg still on, like reducing reserve requirement ratio to 0%, of instance, and cut interest rates, but that’s all they can do without removing the peg.
This article originally appeared here: An Economist At A Government Think-Tank Thinks Yuan Should Be Devalued
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