Shrewd China Move To Fight Inflation, “Currency Wars”

China’s central bank unexpectedly announced Friday night 

China’s central bank unexpectedly announced Friday night 

it would increase the reserve requirement for commercial banks,

the second such move by Beijing this month.

Commercial banks were ordered to transfer an additional 0.5 percent of their assets by Nov. 29 

to very low-yielding accounts at the central bank, the People’s Bank of China. 

It already requires large commercial banks to park 17.5 percent of their deposits at the central bank. 

The new order means that requirement will rise to 18 percent on Nov. 29.

To battle inflation, the People’s Bank is already trying to limit incoming investments 

by people and companies that want to buy Chinese stocks, bonds and real estate. 

Consumer prices rose 4.4 percent in the 12 months through October, 

and broadly measured money supply is up 54 percent in the last two years. 

The move leaves the commercial banks with fewer renminbi to lend, 

which may help cool speculation in real estate and commodities.

The State Council, China’s cabinet, also announced late Wednesday that 

it was drafting price controls for a wide range of foods while seeking to make more food and fuel available. 

Local authorities were also ordered to provide subsidies for the needy.

The commerce ministry said last week it was also tightening scrutiny of incoming investment in new factories and other big projects.

Two Goldman Sachs economists, Helen Qiao and Yu Song, predicted in a research note that 

China might raise the reserve requirement again by the end of this year so as to further limit lending and control inflation.

By comparison, the Federal Reserve sets a reserve ratio of 10 percent for all but the smallest banks in the United States, 

and American banks are not required to hold any reserves against some large categories of deposits.

The central bank relies mainly on these reserves for the renminbi 

to buy about $1 billion a day worth of dollars, euros and other currencies.

Beijing, which has largely resisted United States pressure to let the renminbi rise, has argued that 

the Federal Reserve’s recent easy-money actions are a de facto devaluation of the dollar.

The central bank ordered commercial banks to increase their reserves after many news reports that 

Ben S. Bernanke, the Federal Reserve chairman, would criticize China on Friday for its currency policies. 

But the Chinese central bank issued its new regulation before Mr. Bernanke actually spoke, in Frankfurt.

The bank did not mention the Federal Reserve in its one-sentence announcement, 

which described the move as undertaken “in order to strengthen liquidity management and appropriately control money and credit.”

In China, the renminbi from commercial banks’ compulsory deposits have been the central bank’s main source of money in buying $2.65 trillion worth of foreign reserves. 

Raising the reserve requirement ratio gives the central bank more renminbi with which to buy dollars.

Consequently, some economists were quick to point out that the Chinese central bank had chosen a 

policy stance particularly well suited to holding down the value of the renminbi against the dollar, 

at a time when the Federal Reserve was trying to increase the supply of dollars by buying longer-denominated Treasuries.

Qu Hongbin, the co-head of Asian economic research at HSBC, wrote in a research note on Friday evening that 

higher reserve requirements for commercial banks showed that the People’s Bank

was “prepared to do whatever it takes to fend off the impact” of the Fed’s monetary easing policies.

Most Western economists, and even some Chinese economists, had been predicting that 

the Chinese central bank would raise interest rates instead of raising reserve requirements.

Higher interest rates would also reward depositors, many of whom are elderly Chinese. 

And higher rates would increase costs for borrowers, 

particularly the state-owned enterprises, aka SOEs, 

that account for up to 90 percent of the borrowing in China because of their political clout.

But raising interest rates would also make it even more attractive for international investors 

to buy renminbi and invest them in China, which would very likely lead to a strong renminbi. 

The Chinese government is already struggling to continue holding down the value of the renminbi; 

its basically stable link to the dollar has been crucial to China’s emergence as the world’s largest exporter,

whose large trade surpluses have created millions of jobs in China.

Significantly, China is also moving rapidly into high-value-added advancing sectors,

like the manufacture of telecommunications equipment, cars, solar panels and other sophisticated goods,

in which it competes directly with the United States instead of with emerging economies. 

In these areas, prices are much less important than 

quality and the ability to create products and services that meet previously unsatisfied demand,

which should lessen the misguided discussion about relative currency evaluations,

although it will raise other problems for the US, Germany and other high-tech nations 

that have depended on innovation in advancing sectors to create prosperity since the end of World War II.