House of Paine

an exchange with notes

XXX:
 I THOUGHT THIS WOULD WORK BETTER OFF SITE 
> 
> U ARE VERY KEEN ON THIS NOTION THAT CHINA IS 
>EXCEPTING UNCLE'S IOUs 
> at a face value they will never get close to redeeming them at 
> 
>i think u need to take us  both
 through this rip off end game at least once 
> 
>here are a few no flyers at least to me 
> 
>the bank system balance sheet

on the liability side
  appreciating  rmb 
>
asset side depreciating dollars 
> 
>so what ????

no possible insolvency here

only price level hiccups 
> 
> need to pay off

>the banking system 
can make as many rmb 
as it wants 

or better 
>pay as high an interest rate as it needs 
to roll over the debt 
and 
 keep em in rmbs 

> the party will give em 
> any capital flow regs the cb equires 

----------------------------------------

 side bar:

> 
>am i wrong to say 
>u are using intuitions 
based on non rebust exporting emerging states ??? 
one's  
>with other sorts of a-symetrical balance sheets 
>that pit hard lisbilities against soft assets 
>where the hard liabilities are not in the banks own currency ??? 
> 
>inflation fear ????? 


>well  as i wrote above 
 obviously interest rates can tame a sudden outflow 
> 
>i like the idea of
 land taxes  myself
 sends the  asset  market bubble
 flowing  back into the gubmint coffers 

stock bubbles??

so far the han ain't got much 
 of an equity system 

 interest rate spikes ???

   no way a biggy except
        for wrong bet specs 
 
> 
>i often feel you are judging 
the potential performance capacity of this 
>                                   exceptional economic system 
>                  on other systems you've seen 
> 
>can u say this is not a higher horse power design 
>then say britain or germany in their hay day 
> 
>surely japan was too 
could the han be out japping the japs ????
(in fact with jap help) 

admit it
  so far facts on the ground 
      keep showing 
>this system moves
  like nothin so  big  we've ever seen before 
> 
> 
>by the way 
>at the moment of truth 
>when the rmb is unpegged 
> why assume 
> a race to cash in their rmb balances 
> to buy other currencies??? 
> 
>why then ??? 
>when the rmb is finally appreciating 
> 
>is your trigger for the weak dollar backed rmb loans 
>a trigger at all ??? 
> 
>----------------------------------------------- 
> 
>now here's another look more at real stuff 
> 
>worsed case 
>china figures its dollars are worthless 
> 
>is the present set up still better then to shut down the export expansion 
>by letting the rmb fly up ???? 
> 
>after all that migh seal china off from needed tech flows 
> 
> as in dooley let's pretend this zero margin chinese labor 
>is like a virgin forest 
>(hoteling) 
>is getting a unique vent 
>for this product 
>thru export 
> actually a human capital 
>and r and d expenditure 
>whats the real cost 
>the difference 
>between 
> the exported outputs 
> and the imported inputs 
> 
>not a problem on can solve short of a valuation system obviously 
> 
>but imagine that gap 
>is labor force tuition and apprenticeship payments 
> 
>worth it ??? 
> 
>maybe brad it is worth 
> one or two trillion $ 
> in depreciated foreign holdings 
> 
>hardly the what ya got to show for it blank 
>we call the 5 trillion dollar nuclear arms race ????? 
> 
> unlike oil or silver 
>labor is renewable 
> even super exploitation 
> that allows this labor force to internalize 
>otherwise non availible 
>high productivity skills 
> can from then on be reproduce 
>by this labor force itself 
> as it reproduces itself 
> 
>example 
>from elsewhere 
> 
>whats the human cap value 
> of india's ever renewable 
> huge english competent pop 
> 
>worth 200 years of raj ??? 
> 
> 
-----------------------------------



go to China, come back a Dooley, Garber, Folkerts-landau acolyte ... I am hurt. You should have talked to the folks in the PBoC who want to scale back China's dollar purchases. 
 
I am certainly not using intuition based on non-robust non-exporting emerging economies -- they generally have to worry about a currnecy depreciation, i am focused on a currency appreciation. 
 
and the risks here reside not with private banks -- at least not directly -- but with the central bank. 
 
my argument that dollar assets will not hold their value in RMB terms is hard to refute -- it necessarily is the case if the RMB rises against the dollar over time. and history suggests that fast growing east asian economies whose productivity is growing fast tend to appreciate over time. Now so long as chinese interest rates are lower than US rates, some of the loss on the currency is offset by the positive carry. 
 
but there is no guarantee that positive carry will last, or that it will be bigger than the currency loss. 
 
bottom line -- if you borrowed 10 euros in 2001 at than then bought dollars at .90 dollars/ euro, you ended up with 9 dollars. and those dollars today are only worth say 7 euros. You lost money -- the central bank is in the same position. it has borrowing in RMB to buy dollars. and it seems likely that over time the dollar will fall v. the RMB. 
 
that's just math/ accounting. you know it well from your old job i suspect. 
 
the interesting/ debatable questions: 
 
will china get something in return (technology, skill at exporting, a manufacturing base) that offsets the central banks' losses? 
 
and what are the practical consequences of losses in the central bank? 
 
say right now the CB has $820 b in reserves, offset by liabilities equal to $820 b. and those liabilities are $320 b sterilization bills, and $500 b cash. (all liabilities in RMB/ all assets in dollars). Now suppose there is a 25% RMB reval. the PBoC still has $820 b in assets, but it now has $1000 b plus in liabilities. 
 
So what you may ask -- even if it pays 5% of its bills, the flow cost of $400 b (after the reval) at 5% is $20 b a year, and $820 b paying 4% brings in $32b. the central bank is still generating cash, it is just less profitable than before. 
 
I would argue that is still a cost - the reduction in the central banks profits reflects the oportunity cost of holding a depreciating asset to offset RMB liabiltiies on hte central bank's balance sheet. 
 
But it is a manageable cost. 
 
and so long as capital doesn't start flowing out (in excess of ongoing inflows), the stock imbalane ($1 trillion in assets v $820 b in assets) isn't material. 
 
good central banking practice may imply issuing a $200 b government bond to recap the central bank, but why bother -- is just would increase the central bank's accounting profits and thus the amount it gives back to the government ... 
 
maybe. 
 
but as the stock of bills rises relative to the stock of reserves, the risks to the central bank grow. 
 
and keeping chinese interest rates below the US rate has costs of its own. 
 
Or take another scenario -- after the reval, $240 b (now worth $300b) in original hot money takes its profits and flees, so reserves fall by $400b.  Reserves fall by $300 b from $820 b to $500 b. the central bank no longer needs sterilization bills, so its liabilities fall by $300 b as well, and the central bank is left with $500b backing $700 b in RMB cash -- it still has $20 b in flow profits ($500 * 04%). It just formally lacks enogh backing for all its RMB. no problem tho, so long as Chinese citizens don't try to redeem their RMB cash for $ ... 
 
It some sense, it is all accounting, and it just shows up as smaller CB profits. but there is still a real loss. 
 
I am sure that I am not ignoring China's export strength - its is the export strength that leads to a real appreciation, and makes its advantageous to have $ debts (whose real value falls) and potentially troublesome to hold $ assets. 
 
But then the accouting hole on the cnetral bank's balance is like the current accounting hole on the banking system's balance sheet from bad loans in the 1990s. it shows up as smaller profits than otherwise would be the case had alll funds lent out in the 90s generated loans that peform. but it doesn't otherwise impinge on the operation of the banking system -- since deposits keep flowing into banks that formally lack enough performing assets to back all their liabilities. 
 
Why -- because the government's promise to make the banks whole is credible.  the government's promise to recap the central bank if that becomes necessary is also credible. 
 
but i stand by my argument that reduced profits from the central bank is still a real ongoing loss -- china's high demand for base money should make the central bank very, very profitable. at some point though, its profits will fall below that they should be ... 
 
the debate is over the consequences of this, and wherther china will get so much in return that it is a good trade. 
 
that is a debate for another time! 
 
 
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