I figured out a back way to get in to the account, but it took too much work to post regularly. I’m here in the UAE on business, and have an impossible amount of other stuff to complete, so adding on hassles with proxy servers and the like was a large disincentive. The government appears to have let up on Typepad — meaning that they’ve likely identified and blocked the offending sites — so I’m back on board.
Every month the People’s Bank of China pays 200 billion renminbi to China's exporters to buy up the dollar-denominated assets they have accumulated and so prevent those assets from generating upward pressure on the value of the renminbi. It gets those 200 billion renminbi by borrowing them from the good burghers of Shanghai. By now the central bank owes the good burghers of Shanghai some 16 trillion renminbi. To them, this wealth is nearly as good as cash. It has been piling up for years — and because it is nearly as good as cash, the good burghers of Shanghai should be spending it.
Here is a picture of the assets held by the People’s Bank of China (PBOC). It shows fairly awesome growth, driven entirely by foreign asset accumulation.
They should be spending it. But the goods that are the counterparts of this financial wealth have been shipped via container to Long Beach. So demand in China should be massively outrunning supply, and China should be seeing strong and rising inflation.
Professor DeLong then links to James Hamilton, who suggests that the reason is that monetary growth in China leads to asset price inflation rather than goods-and-services price inflation. He concludes:
The fact that our standard models do not appear — so far — to apply to Chinese inflation is yet another disturbing feature of today's world economy.
I’m not so sure that is correct. Below the fold is a graphical representation of the liability side of PBOC balance sheet:
What does it show? The bottom peach-colored indicator is currency in circulation: the number of literal renminbi printed up. Growth is fairly steady, almost linear. Above it, in orange, is the amount of money that the nation’s banks have deposited at the PBOC. From the Shanghai burghers’ point of view, this is as good as currency in the vault, and it rises slowly and steadily until 2007.
The PBOC kept its huge growth of reserves from leading to a huge growth in high-powered money via the two green indicators. The dark green one represents illiquid bonds that the PBOC basically ordered the banks to hold. The light green one represents government income (likely from state-owned enterprises, but I’m not sure that it matters) that was deposited with the central bank rather than spent. Those two mechanisms mopped up most of the growth in high-powered money.
In 2007 and 2008, things changed. High-powered money started to grow like gangbusters. So why didn’t inflation get out of control? Well, look at the red line: China let the value of the renminbi rise from roughly 12¢ per dollar to a bit over 14½¢. The rise in the renminbi helped keep a lid on import prices. Much as I think that the Chinese government should have let the renminbi rise even more, I’m not sure that the lack of inflation presents much of a mystery.
Fast forward to 2009. The renminbi is no longer rising, so that can’t explain the lack of inflation. Productivity is rising, but probably not enough to explain things. (Productivity increases mean that Chinese producers are using fewer inputs to make the same output, which allows them to hold the line on output prices even as input costs rise, at least over a certain range of cost hikes.) So how are the Chinese keeping inflation down as their reserves continue to balloon?
Well, look at the orange indicator. High-powered money isn’t growing. What is growing is the white block at the top, what the PBOC calls “other liabilities.” I have no idea what those are, but they represent currency mopped up by the central bank. In other words, the PBOC is keeping a lid on inflation by taking in liquid renminbi from somebody in exchange for an IOU of some sort.
At some point, the PBOC will no longer be able to keep up this balancing act. They might sink the economy by sucking up too much liquidity and depriving the private economy of credit. They might lose their ability to control inflation. Or they might let the renminbi rise. But there are reasons to believe — and I should mention that I have changed my opinion on this issue in the last year or so — that the Chinese government and PBOC may be able to keep up the balancing act for some time. 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.
None of which is to say that China is not at the beginning stages of an asset-price bubble. It very well could be; in fact, from the anecdotal evidence, it almost certainly is. But I do not think that you need to postulate a bubble in order to explain the lack of inflation.
Does that solve the mystery, or am I missing something? IANAME, just a fairly ignorant business school professor sitting in a Dubai hotel room wondering how he is possibly going to finish all the stuff he has to do. So I almost certainly am missing something. Thoughts?