Chinese liquidity drill

With floating fx, it’s necessarily about price (interest rate) and not quantity.

That includes China’s ‘dirty float’, a currency not convertible on demand at the CB, but with periodic CB market intervention.

Loans necessarily create deposits at lending institutions, and they also create any required reserves as a reserve requirement is functionally, in the first instance, an overdraft at the CB, which *is* a loan from the CB.

So from inception the assets and liabilities are necessarily ‘there’ for the CB to price.

Liquidity is needed to shift liabilities from one agent to another.

For example, if a depositor wants to shift his funds to another bank, the first bank must somehow ‘replace’ that liability by borrowing from some other agent, even as total liabilities in the system remain unchanged.

That ‘shifting around’ of liabilities is called ‘liquidity’

But in any case at any point in time assets and liabilities are ‘in balance.’

It’s when an agent can’t honor the demand of a liability holder to shift his liability to another agent that liquidity matters.

And if a bank fails to honor a depositor’s request to shift his deposit to another institution, the deposit remains where it is. Yes, the bank may be in violation of its agreements, but it is ‘fully funded.’

The problem is that to honor its agreements to allow depositors to shift their deposits to other banks, the bank will attempt to replace the liability by borrowing elsewhere, which may entail driving up rates.

Likewise, banks will attempt to borrow elsewhere, which can drive up rates, to avoid overdrafts at the CB when the CB makes it clear they don’t want the banks to sustain overdrafts.

The problem is that only the CB can alter the total reserve balances in the banking system, as those are merely balances on the CB’s own spread sheet. Banks can shift balances from one to another, but not change the total.

So when the total quantity of reserve balances on a CB’s spreadsheet increases via overdraft, that overdraft can only shift from bank to bank, unless the CB acts to add the ‘needed’ reserves.

Or when one bank has excess reserves which forces another into overdraft, and the surplus bank won’t lend to the deficit bank.

This is all routinely addressed by the CB purchasing securities either outright or via repurchase agreements. It’s called ‘offsetting operating factors’, which also include other ‘adds and leakages’ including changes in tsy balances at the fed, float, cash demands, etc.

And when the CB does this they also, directly or indirectly, set the interest rate as they do, directly or indirectly, what I call ‘pricing the overdraft.’

So to restate, one way or another the CB sets the interest rate, while quantity remains as it is.

And those spikes you are seeing in China are from the CB setting rates indirectly.

The evidence from China is telling me that the western educated new kids on the block flat out don’t get it, probably because they were never told the fixed fx ‘monetarism’ they learned in school isn’t applicable to non convertible currency???

In any case the CB is the monopoly supplier of net reserves to its banking system and therefore ‘price setter’ and not ‘price taker’, and surely they learned about monopoly in school, but apparently/unfortunately have yet to recognize their currency itself is a simple public monopoly?

Thinking back, this is exactly the blunder of tall Paul back some 33 years ago. He made the same rookie mistake, for which he got credit for saving the US, and the world, from the great inflation of his day.

However, the fact that he made it worse, vs curing anything is of no consequence.

What matters is how the western elite institutions of higher learning spin it all…