Twofish's Blog

January 13, 2010

Notes on Chinese inflation

Filed under: Uncategorized — twofish @ 1:48 am

I don’t see that much of a mystery. The primary way in which the Chinese government controls the economy is through reserve requirements, in which the banks are forced to take a huge amount of their wealth, and keep it in the form of government bonds. The “other liabilities” that you see on the PBC balance sheet consists of bonds issued by the PBC which it forces the banks to hold in as part of it’s required reserves.

Forcing banks to hold required reserves has two major goods point in that:

1) it makes the banks more resistant to shocks. If you have a massive drop in real estate prices, then you have the reserves to prevent a liquidity crisis while you figure out a way of recapitalizing the banks.

2) it gets you out of the liquidity trap. One reason that the Chinese economy bounced back very quickly from the recession, is that the PBC pushed down reserve requirements allowing banks to pump massive amounts of cash into the Chinese economy.

All of this requires a huge savings rate. If you don’t have savings then you can’t have the banks hold large amounts of reserves.

Quote: At some point, the PBOC will no longer be able to keep up this balancing act.

I’d be curious to know why not.

Quote: In theory, I think, it should be sustainable as long as Chinese firms remain profitable enough to finance themselves via retained earnings despite the fact that a big chunk of those earnings wind up metaphorically sitting in the PBOC coffers.

And I don’t see why this can’t continue for another generation. PRC companies have no shortage of capital which they use to build factories which increases productivity which creates more money that gets put into the bank. As long as productivity can be increased by capital expenditure, there isn’t anything that keeps things from growing.

All this will end when you have enough urbanization and capital investment at it’s that point that you might see either a Soviet or Japanese crisis, but that’s at least 20 years in the future. The other thing that will cause disruption is when you have retirees pull money out of the banks, but by that time, you have enough profitable factories so this is possible,


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