China raises bank reserve to curb lending

While this doesn’t actually work to curb lending, it does indicate that China continues to see inflation as a severe enough of a political problem to risk a serious slowdown. And while it’s not impossible, I’ve yet to see any nation succeed in cutting what they call inflation short of increasing their output gap- and most often with a dramatic slowdown.

So while the 9% of GDP US budget deficit continues to support modest GDP growth and only very modestly increasing employment, a combination that’s a pretty good environment for stocks, the risks outlined at year end continue to increase.

China continues to fight inflation which can soften thing sufficiently for a commodities retreat. The euro zone continues its austerity and is already showing sings of weakening domestic demand from levels that weren’t all that high. The US Congress continues to press for deficit reduction well before private sector credit growth is ready to take the hand off, and with all sides agreeing there’s a long term deficit problem there doesn’t seem to be much resistance.

It’s all deflationary, and I continue to watch for a strong dollar as a timing/cue to the potential global slowdown.
So far world crude prices hovering at just over $100/barrel are keeping the dollar in check, but doing so by bleeding off some US domestic demand.

China raises bank reserve to curb lending

February 18 (CNBC) — China ordered its banks Friday to hold back more money as reserves in a new move to curb lending and cool a spike in inflation.

The order raising reserves by 0.5 percent of deposits was the second such move this year by the central bank and followed six reserve increases in 2010. Reserves vary by institution but are about 20 percent for China’s biggest state-owned lenders.

Beijing is using a series of repeated, gradual hikes in interest rates and reserve levels to stanch a flood of lending that helped China rebound quickly from the global crisis but now is fueling pressure for prices to rise.

Inflation is politically dangerous for China’s communist leaders because it erodes economic gains on which they base their claim to power. Poor families are hit hardest in a society where some spend up to half their incomes on food and millions have seen little benefit from three decades of economic reform.

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16 Responses to China raises bank reserve to curb lending

  1. Emily Jones says:

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  2. beowulf says:

    Speaking of China, I saw this story over the weekend…

    Special report: China flexed its muscles using U.S. Treasuries
    NEW YORK (Reuters) – Confidential diplomatic cables from the U.S. embassies in Beijing and Hong Kong lay bare China’s growing influence as America’s largest creditor.

    http://www.reuters.com/article/2011/02/17/us-wiki-china-treasury-idUSTRE71G47920110217?pageNumber=1

    Reply

  3. SethM says:

    Can we say categorically that raising reserve requirements in China does not slow down lending growth without a deep understanding of how the Chinese banking system operates? I think there’s an assumption that in China banks don’t lend reserves and have access to a discount window like in the US. They may very well operate that same as the US, but I think it’s important not to assume this without supporting info.

    Reply

    RSJ Reply:

    I think it’s difficult to believe that, on one hand, banks in the U.S. go to great expense setting up sweeps accounts, lobbying, and taking other efforts to avoid reserve requirements, while on the other hand arguing that reserve requirements do not affect lending.

    If something increases a bank’s cost of funds, it will affect lending.

    Forcing banks to hold non-interest bearing assets when they could be holding interest bearing assets means that for a given balance sheet size, banks will have higher costs per unit of capital committed, and therefore will need to earn more interest income in order to meet their required return on capital.

    On the other hand, perhaps what is meant is that reserve requirements are not a binding constraint — e.g. that banks earn such ridiculous rents that greater reserve requirements merely eat into employee bonuses and do not force the bank to earn more NII in order to meet their cost of capital, since they are earning so much more than that anyways.

    But in that case large reserve requirements are a great idea.

    Reply

    Neil Wilson Reply:

    “and therefore will need to earn more interest income in order to meet their required return on capital.”

    Or the required return on capital will come down, or the capital won’t go through banks but directly to the corporate bond/equity markets.

    Banks really should be in the same investment category as utility companies. Boring and not very profitable due to massive competition/regulation.

    What’s not to like?

    Reply

    WARREN MOSLER Reply:

    I mean the bank’s ‘available quantity’ is not affected, as it’s a function of capital regs, etc. and even capital is endogenous as well.

    it’s about price, not quantity, etc.

    Reply

    WARREN MOSLER Reply:

    agreed

    Reply

  4. Geoff says:

    Warren,

    Could you please elaborate on how higher oil prices help to keep the dollar in check? I assume you mean that higher oil somehow makes dollars “easier to get”, but am unclear exactly how.

    Reply

    Zaid Reply:

    Your assumption is correct. It makes more dollars available to the rest of the world via the current account deficit and thus the effect on FX.

    However, if these dollars are not replaced by government spending, it reduces net financial assets of the domestic non-government sector.

    Reply

    Geoff Reply:

    Thanks, Zaid.

    Reply

    WARREN MOSLER Reply:

    our import bill goes up

    Reply

  5. Paul M says:

    There is a lot of talk of the growing gap in this country between the wealthy and poor, particularly in the past few years. Given the “prosperity” and the continued growth of the Chinese economy is there any evidence that it is worse/better there than here? Basically as the Chinese economy continues to grow is any of the benefits flowing down to the poor sectors of the Chinese society.

    Reply

    Tom Hickey Reply:

    That’s the challenge the leaders face. Their export model works at the expense of the people for the most part, so far. Domestic consumption is estimated at only 36% of GDP versus the US at 70%. That makes for an imbalanced economy at the mercy of global trade.

    Considering the magnitude of global trade imbalances, that is a precarious place for the Chinese leadership to be sitting. They know it and are working on it before it blows up in their faces. But they have a huge population to deal with. This is going to be a balancing act, and it will be a miracle if they can pull it off without any major glitches in the plan, or shocks that upset the plan. It’s definitely juggling with knives.

    Reply

    Oliver Reply:

    The rural and urban populations are kept pretty separate in China. Poor farmers who come in from the country side need a residence permit for the city, which they mostly don’t get. So they end up as illegal workers in the sweatshops on the outskirts of the boom towns, a fact that has kept them silent until now. And as long as there are enough other low-skill, illiterate peasants waiting in line, chances are that won’t change. Criminalizing the poor, the great leap sideward :-).

    And although the US is not far behind China in terms of inequality, it is unequal at an altogether higher level of income. So much less absolute poverty to deal with.

    Reply

    Tom Hickey Reply:

    The problem with the peg driven export model is inflation, which results in higher food prices, meaning scarcer food for the poor people. The Communist Revolution was about providing “the iron rice bowl,” that is, sufficient food as affordable prices for the multitudinous poor. Take that away and the history of China is replete with the consequences. The leadership is well aware of this and terrified of those consequences.

    Reply

    Oliver Reply:

    True, which is why they’re running the high growth strategy in the first place. Still, I believe what counts as appeasement in China wouldn’t pass any basic test for equity or other democratic principles in other countries such as the US.

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