Comments on: "China’s Inflation Hits American Price Tags"

By: Yves Smith

Yves Smith — Fri, 01 Feb 2008 21:43:00 +0000

Actually, some relevant commentary comes from Nouriel Roubini, in a summary of his paper "The Instability of the Bretton Woods 2 Regime":

...membership of BW2 leads to significant financial, monetary and real distortions for its members, most of which have to do with the loss of monetary and credit policy independence that a fixed exchange rate peg entails. These distortions are increasingly taking the form of economic overheating, rising inflation and dangerous asset bubbles.

China is a paradigmatic BW2 member.

By: Yves Smith

Yves Smith — Fri, 01 Feb 2008 21:10:00 +0000

I didn't get into sterilization versus non-sterilization issue, incorrectly deeming it to be too technical, although I should have at least alluded to it.

The social unrest resulting from dollar-induced inflation is one of the reasons China is letting the yuan rise. I have not yet tracked it down, but I recall reading Brad Setser saying that it wasn't clear whether China was sterilizing its Treasury purchases before 2005 (he may actually have said something stronger, as in they likely weren't). Any past unsterlized Treasury purchases would have led to domestic money supply growth.

He also said in post this week that even permitting the currency appreciation, China was currently having trouble sterilizing its Treasury buys.

By: wprestong

wprestong — Fri, 01 Feb 2008 18:12:00 +0000

anonymous is half right. The Chinese buy US Treasurys. But then, in order to control their own money supply, they turn around and sell renminbi-denominated bonds, to suck back the renminbi cash they just put out. So the net trade is buy US Treasurys, sell renminbi bonds.

This is called sterilization. The Japanese also do it. It is leaky, though. It does not always work to control the money supply.

Note that it also makes the reserves in the Chinese central bank worse and worse. I wouldn't be surprised if the Chinese central bank is the only institution in China that owns no renminbi-denominated bonds.

By: Anonymous

Anonymous — Fri, 01 Feb 2008 14:00:00 +0000

The Chinese peg their currency to the US$. Therefore, they must buy (support) the $’s fall by buying Treasuries.

Those Treasuries then become the reserves undergirding China’s monetary base.

By: Felix

Felix — Fri, 01 Feb 2008 13:54:00 +0000

Yves, I think you’re exactly wrong on this one. The purchases of dollars aren’t a monetary stimulus — how can buying Treasury bonds increase the Chinese money supply? Quite the opposite: they’re an attempt to sterilize all those dollar inflows, and *prevent* inflation. If China allowed its exporters to simply spend all the dollars they’re earning, *that* would be inflationary.