How China’s cash injections add up to quantitative squeezing
NARY a week has gone by this year without news of China’s extraordinary injections of cash into its own economy. The central bank has pumped hundreds of billions of yuan into the financial system through an admixture of short-term, open-market operations; medium-term credit instruments; and direct loans to state-owned banks. Many have described it as Chinese-style quantitative easing (QE). When a central bank buys up assets to expand its balance-sheet, it is indeed a modern-day form of money printing, and deserves to be labelled as QE. There is just one rather inconvenient fact when Chinese finances are examined more closely: in purely quantitative terms, the central bank has been tightening, not easing. And it has been doing so for several years already.
The chart below shows the balance-sheets of the world’s four major central banks. The QE paths of the Federal Reserve, the European Central Bank and the Bank of Japan are well documented by the size of their assets, depicted by the blue lines in the chart. The Fed’s balance-sheet swelled in three large steps: QE1, primarily in 2009; QE2, from late 2010 to mid-2011; and QE3, the final surge that started in late 2012 and ended last year. For the ECB, the squiggle shows a brief lift from the cheap loans it provided to banks in 2011 and 2012, followed by a retrenchment as concerns about potential inflationary consequences prevailed, and then a big rise since the start of this year, when it officially launched QE. Japan’s trajectory has been pretty much straight up since April of 2013 when Haruhiko Kuroda, the BoJ’s governor, first fired his monetary bazooka.
What of the People’s Bank of China? The PBoC’s balance-sheet rose at a very steady incline for much of the past decade but it has flattened out over the past year. It held basically as many assets at the end of June this year as it did a year earlier—so much for the great, big Chinese-style QE.
It is even more striking when the Chinese central bank’s balance-sheet is assessed as a portion of GDP. This indicates how much base money (ie central bank-issued currency) is being created relative to the size of the economy. To simplify a bit, the monetary base needs to keep up with the economy, otherwise it becomes a constraint on the broader money supply, credit issuance and, ultimately, economic growth. In China’s case, as the brown line in the chart shows, the PBoC’s balance-sheet has been declining as a percentage of GDP since 2010. That is the very time that the government began to worry about the waste stemming from its massive stimulus, started in late 2008, to fight off the global financial crisis. (For other countries in the chart, the brown lines parallel the blue lines much more closely, because their GDP figures, the denominators, have increased much more slowly than China’s.)
Still it would be wrong to describe China’s overall monetary stance as tightening. The central bank is, in other dimensions, loosening policy. It has cut benchmark interest rates five times in the past year. Through its multiple cash injections, it has steered down borrowing costs in the interbank market. It has cut banks’ reserve-requirement ratios (RRR), freeing up more cash for them to lend without actually expanding the monetary base. Indeed, the broad M2 measure of money supply, which includes savings deposits at banks and money-market funds, has grown considerably faster than the money base (11.8% year-on-year in June for M2 versus 3.2% for base money). That is partly thanks to the RRR cuts and also partly a reflection of a faster credit multiplier, which tends to arise as financial systems grow. In this respect, it could be argued that the central bank’s quantitative tightening is actually more a matter of its leaning against the wind, as it knows that money growth has momentum of its own.
This leaves unanswered the question as to why there have been so many headlines about Chinese QE when just the opposite has happened. The confusions appears to stem from the two different channels through which a central bank can create money. One is external-facing: if a country is running a current or capital-account surplus, the central bank can buy the foreign cash entering its borders, issuing domestic currency in exchange. The other is internal-facing: the central bank can buy domestic assets held by the country’s banks (QE is an example of this). For years, the Chinese central bank relied almost entirely on capital inflows from abroad as a source of money creation. The boom in its foreign-exchange reserves since 2000 translated directly into monetary growth at home.
Over the past year, with inflows tapering off and, in recent months, swinging into reverse, China has switched to relying on the purchase of domestic assets to expand its money supply. Capital outflows raise other concerns—most crucially, how long China can afford to run down its reserves to support the yuan and why it is so reluctant to let its currency fall. But as far as the central bank’s cash injections go, they are themselves not cause for alarm. Buying and selling domestic assets is standard operating procedure for central banks managing their money supply. Chinese-style QE may come someday. But it has not started yet.