Best of the Week
Most Popular
1.Putin’s World: Why Russia’s Showdown with the West Will Worsen - John_Mauldin
2. Stocks Bull Market Grinds Bears into Dust, Is Santa Rally Sustainable? - Nadeem_Walayat
3. Gold and Silver 2015 Trend Forecasts, Prices to Go BOOM - Austin_Galt
4.Gold Price Golden Bottom? - Toby_Connor
5.Gold Price and Miners Soar on Huge Volume - P_Radomski_CFA
6.Stock Market and the Jaws of Life or Death? - Rambus_Chartology
7.Gold Price 2015 - EWI
8.Manipulated Stock Market Short Squeezes to Another All Time High - The China Syndrome - Nadeem_Walayat
9.Gold, Silver, Crude and S&P Ending Wedge Patterns - DeviantInvestor
10.Is the Gold And Silver Golden Rule Broken? - Michael_Noonan
Last 5 days
Ruble Takedown Exposes Cracks in Putin’s Defense - 20th Dec 14
Oil Drilling Our Way Into Oblivion - 20th Dec 14
Stocks Bull Market Resumes - 20th Dec 14
Gold And Silver Nothing Is Ever As It Seems And No Respite For PMs - 20th Dec 14
What Are Technical Indicators Saying About the Stock Market? - 20th Dec 14
Here’s How You Can Still Make 27% With Apple Even if You Buy Now - 20th Dec 14
Gold Stocks to Shine in 2015 - 19th Dec 14
Why Alibaba Stock Shares Are a Screaming Buy - 19th Dec 14
China, Dollar, Japan, Europe Burning Questions for 2015 - 19th Dec 14
U.S. Economy is in a Sweet Spot! - 19th Dec 14
US Dollar and the Gold Fairy Tale - 19th Dec 14
Show Me The Money (Flow)! Tracking Money-Flow Through Value Shifts In Stock Markets - 19th Dec 14
The Commodities Market Is Not Dying, It’s Just Hibernating - 19th Dec 14
The Price Of Gold And The Art Of War - 18th Dec 14
Euro Succumbs to ECB QE Expectations and FOMC - 18th Dec 14
John Williams: A Downhill Run for the U.S. Dollar in 2015 - 18th Dec 14
Outrage at Taliban Islamic Fundamentalists Massacre of 132 Pakistani School Children in the Name of God - 18th Dec 14
How Inflation Changes Retirement Benefit Choices - 17th Dec 14
The Real Reason It's Tough to Beat the Stock Market - 17th Dec 14
Russian Currency Crisis and Debt Defaults Could Create Contagion in West - 17th Dec 14
How to Profit From Russia's Stock Market Crash - 17th Dec 14
Russia Crisis - If You Put Your Money in the Bank Will You Get it Back? - 17th Dec 14
Crude Oil Price Crash, U.S. Employment and Economic Growth - 17th Dec 14
Opposing Forces At Play In Gold and Silver Precious Metals Complex - 17th Dec 14
Wall Street Will Always Find An Excuse For Not Raising U.S. Interest Rates - 17th Dec 14
Torture, Terror And Elite Schizophrenia In The UK - 16th Dec 14
Eurozone Conflict Will Bring a Major Stocks Buying Opportunity - 16th Dec 14
Viewing Russia From the Inside - 16th Dec 14
Gold and Silver Stocks Bottom - Are We There Yet? - 16th Dec 14
The Financial Industry Pigmen Win Again - 16th Dec 14
Crude Oil Price Epic Blowout - 16th Dec 14
Asian Stocks Markets: Sand In The Gears Of The Bull Market - 16th Dec 14
U.S. Dollar Trend Forecast 2015 - Video - 16th Dec 14
Silver Price Bottom? - 15th Dec 14
Gold Price Base Building Bullish Pattern - 15th Dec 14
Stock Market Probable Pop-n-Crash Today - 15th Dec 14
Stock Market Time for a Bounce - 15th Dec 14
Stock Market Euphoria: The Mother of All Ponzi Schemes - 15th Dec 14
Gold - The Weight of Time as Trend - 15th Dec 14
U.S. Dollar Collapse? USD Index Trend Forecast 2015 - 14th Dec 14
The Rushing Stocks Bear Market and How to Prepare - 14th Dec 14
Gold and Silver Dreaming of a White Christmas - 14th Dec 14

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Dramatic Stock Market Selloff

People's Bank of China Takes With One Hand, Gives With The Other?

Interest-Rates / China Economy May 19, 2007 - 09:30 AM GMT

By: Paul_L_Kasriel

Interest-Rates The People's Bank of China (PBOC) announced today that it was raising the required reserve ratio on its constituent banks by 0.5 percentage points to 11.5%. This would be the eighth increase in the required reserve ratio since June 2006 when the ratio was 7.5%. You would think that with the PBOC mandating that banks now hold more reserves, the cost of reserve credit would be moving up. Think again. Chart 1 shows that the Chinese overnight interbank interest rate, the equivalent of the U.S. fed funds rate, stood at 1.57% in March (latest data that I have available) - 12 basis points lower than where it was in June 2006, before the required reserve ratio started its ascent.


Chart 1

If the demand for something has gone up, in this case, the dictated demand for bank reserves, how can the price of that something, the overnight interest rate on bank reserves, stay almost the same? The supply of that something, bank reserves, must have gone up commensurately. Chart 2 shows that the year-over-year growth in reserves created by the PBOC jumped from 10.0% in June 2006 to 23.1% in March 2007. In effect, it looks as though the PBOC has been "sterilizing" its reserve-requirement increases.

That is, the PBOC is accommodating its imposed increased demand for reserves by "printing" more reserves, effectively keeping the interest rate on reserve credit essentially unchanged. This might explain why the year-over-year growth in the Chinese M2 money supply in April 2007 was 16.99% -- not much different from the 17.03% in June 2006, just before the required reserve ratio began being raised (See Chart 3).

Chart 2

Chart 3

Why is the PBOC cosmetically tightening its monetary policy? It might have something to do with the more rapid increases in the prices of consumer goods and services of late (see Chart 4) and the more rapid increases in the prices of Chinese corporate equities of late (see Chart 5).

Chart 4

Chart 5

Now, with today's announcement of an increase in the required-reserve ratio, the PBOC also announced some increases in interest rates - just not increases in the interest rate on reserve credit. The PBOC increased the interest rate on one-year bank loans by 18 basis points to 6.57% and the interest rate on one-year bank deposits by 27 basis points to 3.06%.

With consumer price inflation running "officially" at 3.0% and with stock prices growing at an annual rate of almost 200%, why would many Chinese find a 3.06% nominal return on their savings very attractive? In other words, it is doubtful that the PBOC's deposit interest rate increase is going to do much to slow down the velocity of M2. Likewise, a 6.57% borrowing interest rate in the face of an almost 200% annual increase in stock prices is unlikely to slow significantly the demand for bank credit. And U.S. banks can only look on in envy at Chinese banks that can fund themselves overnight at 1.6% and lend for one-year at 6.57%. In sum, it does not look as though the steps taken today by the PBOC on reserve requirements and interest rates will do much to slow down bank credit / money supply growth and, thus, consumer price and asset price inflation unless these steps are taken in conjunction with a sharp slowdown in the PBOC's provision of bank reserves.

A slowdown in bank reserve provision would lead to a rise in the overnight interbank interest rate. The rise in this rate also would put upward pressure on the yuan/dollar exchange rate. And the PBOC also announced that it would allow the yuan/dollar relationship to vary more on a daily basis - from 0.3% to 0.5%. Under current conditions, the only way the PBOC can rein in consumer and asset price inflation is to slow down the provision of bank reserves and that will entail a rise in the yuan relative to the dollar. The PBOC has to make a decision - does it want to maintain a relatively steady yuan/dollar relationship or does it want to prevent Chinese inflation? It can't have both. As the Chinese say, "May we live in interesting times."

By Paul L. Kasriel
The Northern Trust Company
Economic Research Department - Daily Global Commentary

Copyright © 2007 Paul Kasriel
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.


© 2005-2014 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Free Report - Financial Markets 2014