China is suffering from rising inflation, as well as a runaway stock market bubble, both side effects of its rapidly growing foreign exchange reserves. But rather than raise interest rates, which would rein in price growth but also increase the price of the yuan, the Chinese are instead engaging in extreme measures to combat domestic price pressures.
As we noted earlier, currency experts like Menzie Chinn believe that China has not (perhaps until recently) been sterilizing its foreign currency purchases. Unsterilized increases in FX reserves translates into domestic money supply growth.
The first drastic move took place in September, when China imposed a price freeze on all goods where the prices are set by the government. Today, the Wall Street Journal reports that China has told banks to stop making new loans at least through the end of the year. Note that the Journal presents this as a measure to combat speculative investment. However, the populace is increasingly angry about rapidly rising prices, and containing them seems to be at least as important an objective.
From the Journal:
In recent weeks, regulators have quietly ordered China’s commercial banks to freeze lending through the end of the year, according to bankers in several cities. The bankers say that to comply, they are canceling loans and credit lines with businesses and individuals….
Curbing lending by raising interest rates, as China already has done four times this year, would be more in keeping with Beijing’s increasingly market-oriented approach to business. But the lending freeze shows how the slowing U.S. economy may be complicating Chinese policy making. Lower interest rates in the U.S. give Beijing less room to push up rates without creating a ripple effect.
By raising rates further China could risk boosting the value of its currency, the yuan, too much for the comfort of its exporters, a critical part of the Chinese economy. A stronger yuan would make Chinese exports less competitive in world markets.
Bankers say they will honor the lending edict, partly because it comes with threats of financial penalties for noncompliance. “Which commercial bank would dare not obey this?” says Liu Haibin, chairman of the supervisory committee of Shanghai Pudong Development Bank Co….
How much lasting impact the measure has could depend on whether it is extended in some form in January, bankers say.
Even a temporary lending freeze, however, could cast a chill on important segments of the Chinese economy, including the stock market, whose steep run-up over the past year has given rise to fears of a speculative bubble. Though off their highs, Chinese share prices have nearly doubled since late 2006.
The lending freeze doesn’t appear directly related to concerns about a stock bubble….
Less lending also could rein in China’s resurgent housing market or hurt consumer confidence. Some companies operating in China, particularly smaller ones, may be hard put to find basic working capital to pay staff or buy materials at year end, bankers say…..
It has been three years since Premier Wen Jiabao pledged to deal with “severe” problems associated with rampant credit growth. But despite repeated rate increases, economic data still point to risks that haphazard investment could make the Chinese economy spin out of control and possibly lead to hyperinflation or a spate of bad loans…
Gross-domestic-product growth, at 11.5% in the first nine months of 2007, is on pace this year for its fastest rate since the blowout years of the early 1990s, when growth peaked at more than 14%. Soaring food prices and rising fuel charges are sowing concerns about consumer-price inflation — which in October stood at a decade high of 6.5% — and risking social discontent.
It isn’t easy to predict whether a pause in bank lending so late in the year might dent China’s economy. Several bankers said the fourth quarter is generally quiet for lending anyway, and that many banks have already met or even exceeded year-end lending targets. In late 2005 and 2006, regulatory officials backed up rate increases by jawboning bankers to slow lending in the fourth quarter, but bankers say the end result was a rebound in lending in the first quarter of the following year.
Individuals may be less affected than businesses because smaller loans may not raise eyebrows like big corporate working-capital loans. But at least one property agency in Shanghai is advising clients to delay mortgage applications until January…
Instead of trying to target lending levels, economists say China could try to damp credit expansion by pushing up interest rates and letting the yuan appreciate against the U.S. dollar, since both adjustments would make borrowers and lenders think twice before committing to projects. U.S. officials, including Treasury Secretary Henry Paulson, regularly deliver such a message, saying a more market-oriented financial system is in Beijing’s own interests.
But after its four interest-rate increases this year, the People’s Bank of China appeared to question that idea after the Federal Reserve cut U.S. interest rates in September to offset turmoil in the subprime-mortgage market.
Beijing’s concern about the stability of the yuan may be the reason, since higher interest rates tend to attract more depositors, an unwelcome prospect for Chinese policy makers keen to minimize enthusiasm for the yuan. A stronger yuan could hurt exporters by making some goods more expensive for buyers paying in dollars or euros