On January 7th, my email message to clients started: “If China has a policy or a strategy for the Rmb, now would be a good time to reveal it. In the absence of a plausible and public strategy, the markets have conjured up enough feedback mechanisms to produce a genuine simple currency crisis.”
Five weeks later, PBOC governor Zhou Xiaochuan has produced an unprecedentedly lengthy and detailed account of policy strategy and tactics imaginable - a compendious response. Not only is it required reading for anyone involved in China now, but I suspect it will become something of a locus classicus for anyone wishing to understand Chinese financial policy development for years to come.
Governor Zhou’s exposition is contained in a c7,800 word written ‘interview’ published in Caixin, formerly seen as the house-mag of Zhu Rongji’s successors. I think it’s a mistake to attempt a precis, because such cherry-picking actually negates the key thrust of the message - that China has sufficient confidence in its policies to explain them in detail, including discussing the challenges and uncertainties which they encounter, and the mistakes made. Instead, you should set aside an hour to read it here: Zhou Xiaochuan's Caixin Interview.
China rarely really explains what it thinks it is doing, and how it intends to go about it. It doesn’t happen very often because such public assertion is impossible without rock-solid foundations of political consensus and coherence. Chinese politics is a tough game, so no-one goes beyond bland in public without having squared or neutralized any potential opposition beforehand.
This is why it is so important: such a public assertion means that what it lays out should be taken at face value. Serious deviation from these positions will be extremely unlikely whilst Mr Zhou remains in public view. The tone adopted is also important, and doubtless has been carefully calibrated. It features frequent acknowledgement of the limits of central banks in dealing with human nature (at one point, he includes ‘original sin’ as a reason for capital flight; at another, he points out that central banks are neither God nor magician). He is surprisingly clear-eyed about the compromises previously accepted in policymaking and their legacies.
So what does it cover?
• fx reform;
• capital flight and capital outflow;
• reserves management;
• the balance between tactics and strategy in policy formulation and exercise;
• PBOC’s role in communicating policy;
• legacy of policy mistakes;
• the competing or complementary roles of macro-prudential policies and macro-prudential regulation (a shot across CBRC’s bows?).
And more.
This interview is surely intended to help restore international confidence in China’s policy making, and my guess is that it will succeed.
My fundamental view is that the current volatility in financial markets is not, ultimately, about imbalances in the world economy, but rather about the historic break-down of the global oil-cartel and the fragility this has revealed once again in the world’s banks. Together these have resulted a fall in cross-border lending since mid-2014. And that has drained liquidity throughout the world in defiance of everything central banks have sought to achieve. China has been the single largest target because, as bank robber Willie Sutton explained ‘that’s where the money is’: withdrawal of bank lines (or paying down dollar debt) has formed the nucleus of the exodus of capital from China.
As Mr Zhou says at several points in his ‘interview’ this will necessarily burn itself out sooner or later. (Probably sooner, given that Hong Kong’s net exposure to China has probably reached zero by now).
There are two positive factors which currently are emerging which might help:
i) The inclusion of the Rmb into the IMF’s Special Drawing Right basket. It’s coming in October 2016.
ii) The agreement reached between the US and EU financial regulators to mutually recognize each other’s clearing arrangements for swaps and derivatives contracts. The key role of CDSs during the financial crisis, with banks belatedly discovering the terrible difference between ‘clearing’ and ‘offsetting’ made properly functioning clearing essential. But the sustained lack of recognition of ‘equivalence’ must surely have been a drag on cross-border liquidity. If this is now being removed. . .
To this can be added a third: China’s demonstration of clarity of purpose, and confidence in its goals, delivered in Mr Zhou’s ‘interview’.
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