Contractionary Monetary policy, China, Paulson, trade deficits…

It’s almost a shame I’m done writing the final exam. Actually I’m not — I can’t get it printed until Monday morning — but it’s probably too long already. The last thing I need is another question in there.

China ordered banks to increase reserves by the most in four years to try to prevent the world’s fastest-growing major economy from overheating.

Lenders must put aside 14.5 percent of deposits as reserves, starting Dec. 25, up from the previous 13.5 percent, the People’s Bank of China said today on its Web site. The ratio is the highest since at least 1987 when the data began and the increase is twice as much as the nine others this year.

Impressive. Bloomberg (the wire service) seems to pin a lot of it on Paulson, though:

The decision comes before a visit to Beijing next week by U.S. Treasury Secretary Henry Paulson, who said Dec. 5 that China’s government should allow the yuan to appreciate at a faster pace to reduce the nation’s record trade surplus.

Paulson has argued a stronger yuan would slow the expansion of China’s trade surplus and reduce tension with international trading partners.

“A more flexible currency is especially important now, when the risks of inflation are clearly rising,” Paulson said in a speech in Washington this week.

a) Paulson should be more concerned about his domestic economy than his economy’s balance of payments or terms of trade (I think); (b) exports hire too many people: China clearly would rather deal with this on a slowly, slowly basis — something Paulson could call up Bernanke to have explained. If he’s not too busy dealing with that investigation in Goldman’s CMO shenanigans; and, finally, (c) could we/the US please accept that the demand side of Problems International are usually those to be addressed? China does not have to respond to the fact that we can’t compete, level playing field or not.

We aren’t exactly apologising to every poor bastard we’ve dragged through the Appellate court of the WTO, while dumping our goods in their markets. Nor do we apologise to the poor bastards we put out of business with our food aid.

Bloomberg, meanwhile, seems to be over-selling Paulson’s influence. I would suggest that the strongest correlation with this move is those nine previous increases, rather than Hank Paulson. We can all agree — put them to one side, and I reckon most knowledge Chinese officials would, too — that currency appreciation, rather than Required Reserve Ratio appreciation in the face 18% Money Supply growth, would do more to slow inflation. The choice is whether to slow Bank profitability, or put exporters out of business. The US can move softly, softly and hope for the best — why can’t everyone else?

I shall be interested to see how exposed to foreign capital China is: Australia, for example, is an exposed economy wherein, upon trying to lower the Money Supply to increase Interest Rates to lower Investment to lower Aggregate Demand to lower Inflation, the influx of foreign cash in response to said rate increases had a positive effect on Investment, un-doing the work, but also lowering Net Exports, thanks to currency appreciation (no, I do not like speculators). In that vein, Secretary Paulson could, perhaps, take the time to talk to, say, Goldman Sachs, UBS, Credit Suisse and Morgan Stanley:

Credit Suisse and Morgan Stanley have each signed agreements with Chinese partners to establish mainland investment banking joint ventures.

The deals signal that Beijing is poised to relax a two-year ban on foreign investment in the country’s securities industry.

Only Goldman Sachs and UBS won approvals before China stopped such deals, fearing that overseas companies would dominate the industry.

The inability of most foreign groups to underwrite mainland IPOs or trade domestic securities has proved costly with the stock market booming and A-share listings in Shanghai and Shenzhen raising $60bn this year.

By way of points of reference, the percentage point increase in China’s Required Reserve Ratio is expected to remove around USD51bn from the economy (the economy that made USD470bn or so in loans, this year).

Alternatively, here is a thought-experiment: rather than taking care of their own interests, suppose the finance ministries of the OPEC countries (Arab and otherwise) started actively touring the world, lecturing everyone on how the US should do something about its depreciating currency and record levels of debt.

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