The pandemic has exposed radical differences in the conduct of monetary policy between China and the rest of the world. This is only the start of the story.
hi - yes planning to revisit in Feb. we received a lot of feedback here. lack of near term directional implications is a solid point & a contrast to crypto. hence the hype in crypto, and knowledge deficit wrt CBDC. tku
There are a number of fundamental issues with this note including the assumption made from the decomposition of M2 (US the multiplier can go negative, in China 90% of the banking system is state controlled so money will get lent regardless of market demand thus ensuring the multiplier is steady). But most importantly its the misplaced focus on the PBOC. It's balance sheet simply doesn't matter. China stopped running a fractional system since 2015, since then money supply and system-wide credit creation has been unbridled by central bank base money. As a result the increase in banking assets (and thus M2) so dramatically dwarfs anything seen anywhere else in the world ever. China's domestic banking assets equal 50% of global GDP, which means nearly $50trn in captive domestic assets. That means a wall of money going in the other direction, not waiting to get into China, but waiting to get out! As a share of GDP M2 increased 40ppts in China in the last ten years, whereas the US, even with the recent surge, is only up 30%. That speaks to persistent outflow and depreciation pressure over the long run. As an example, the only country that beats China in terms of M2 growth is Japan and over that period JPY has depreciate nearly 20% in real terms, while the RMB has appreciated. Why? capital controls. They can maintain the status quo as long as they are in place, but don't fool yourself into thinking the flow pressure are in the other direction.
"The most far reaching implication is that the PBOC develops a capability to sidestep the commercial banking sector and is able to transmit monetary policy directly and digitally to households, whilst also incentivizing consumption via negative interest rates or other forms of time decay."
My belief is that the digital yuan is the Chinese government's official version of Universal Basic Income (UBI). Chinese industrial policy has created a surplus of production capacity, but demand has been slow and unpredictable in its growth. China's population growth rates are also collapsing, and with increasing automation, many jobs are likely to disappear. Unemployed people spend very little, which is not good for the economy. In changing times, the best policy is to introduce a digital yuan issued by the People's Bank of China, but which is only available to Chinese citizens as part of China's version of UBI, and which cannot be accessed by foreign banks and currency speculators.
The advantage for the Chinese government is that it goes directly to the mobile phones of Chinese consumers, its spending can be tracked through the WeChat and AliPay accounts. The People's Bank of China will capture REAL-TIME ECONOMIC DATA as it happens! It can't get better than that. In addition, foreign bankers and speculators will be locked out because it will be designed to be INCOMPATIBLE with the Swift clearing system. Can you beat that?
Chinese businesses will benefit because they will have cash flow, stimulating the Chinese economy. Even as China turns gray, Chinese spending will stay at a healthy rate. All this, while the economies of the US, EU and Japan stagnate.
The digital yuan is basically China's answer to a rapidly graying population, the decoupling of Chinese supply chains and economies from western economies, and the general ups and downs which most economies face. Because it is directly distributed as basically a gift to Chinese citizens past a certain age and those facing unemployment, how much is distributed can be adjusted every month.
Hi. I agree with everything you said in this article, and have no idea as an investor how to position myself, other than perhaps buy Chinese stocks. Are the implications obvious, and will you be writing more about them? Thanks.
Agree that, frightening as it is, CBDC is coming, and with that, possibly a very heavy regulatory hand on crypto.
But I would say that developed country banking systems, though fiat, have long stopped being fractional reserve based (starting 30 years ago, with the last vestiges now totally gone). Whereas fractional reserve continues to be the main tool for central banks in countries with developing financial systems (such as China) that don't have (or don't wish to allow) capital market issued securities substitute for the role of reserves held. Ergo, you are comparing apples with oranges.