To prevent excess liquidity and offset the rise in money supply resulting from intervention, a central bank must opt for "sterilization" policy. The most typical method (sterilization in a narrow sense) is to withdraw base money through open market operations: selling of government and/or central bank bills in the market (see note 3). The simultaneous conduct of intervention and sterilization (open market operations) is called "sterilized intervention," whereas intervention unaccompanied by sterilization (open market operations) is called "unsterilized intervention."I was unaware of this. Probably because I'm still an amateur. But it makes sense...terrible, terrible sense. You've already read about how China keeps its currency down. Basically, the Chinese import US Treasury debt instead of actual goods, flooding forex markets with their own currency to keep their currency down. This is necessary because the US floods the same forex markets with its own currency to buy imports in excess of its own exports, leaving lots of dollars laying around. The Chinese currency used to buy the debt is "printed" by the People's Bank of China (PBoC, China's central bank). (Remember, when a central bank buys an asset, it does so with money which did not exist before. This is the unique quality of a central bank.) Blah, blah, been there done that. Of course, the printing of currency causes domestic inflation. Naturally. China has had a bad case of inflation for quite some time. Which is bad. But it is worse than that, as my own stupid self is just now finding out. The "sterilizing" that this article is talking about is the selling of debt by the PBoC to "re-absorb" that same currency it printed to buy the US Treasury debt! Just as when a central bank buys assets, it puts more currency into the money supply, when it sells assets, it takes money out of the money supply. Do you understand just how insane this is! This is not like normal debt. All governments sell bonds to raise money for various purposes. These actions are neither inflationary nor deflationary, because the money passes from the buyer of the bond to the government, then back into the economy for whatever it is the government is buying. So the money supply is not changed. It's just a way of raising money to do something that presumably needs to be done. This is completely different. These bonds are being sold, and the money used to buy them IS BEING DESTROYED! The government pays interest on money it borrows TO DO NOTHING! The "borrowing" is solely for the purpose of removing money from the money supply. If it wasn't crazy enough that the PBoC printed money to buy debt, they are burning money for the purposes of reducing inflation! Does it get any crazier than this? So, to sum up, net effect is that the PBoC is buying US Treasury debt, and borrowing the money of its own people to do it. This is the arbitrage that the article refers to. China is buying the debt of a soon-to-be-bankrupt country, and borrowing the money to make the purchase. The market for debt is therefore completely artificial. It is not bought or sold due to estimations of intrinsic value. It is done to keep goods flowing in the way China's government would like for them to flow, regardless of price. This is necessary for China to remain competitive in our markets. And of course, the US takes full advantage of this, printing its own money and running up its own debts because it knows China will suck it up and buy more just to keep its position intact. At least, it has up until now. This folks, is "free trade." This is the true nature of globalization. I am beginning to have my doubts that China is truly poised to become a superpower. Its main claim to fame, its success with "command capitalism," is completely artificial. Without these manipulations, China would not be competitive at all. On top of that, anyone should be able to look at this scenario and know how foolhardy and dangerous the pursuit of this policy is. This will come unwound. It will not be pretty when it does. Sadly, it is very likely that China could emerge from the next few decades the premier world power. But if this behavior is any indication, and if indeed it does happen, it will not be due primarily to China's intrinsic economic competitiveness. Not that I have anything against them; I wish them the best. Personally, I would like to see them and everyone else grow wealthy on their own merit, as it is only fitting for virtue to find reward. More virtue and wealth in the world is always a good thing. But this outcome will not have been the result of merit. It will be due to a fall from grace on the part of the US.
Wednesday, January 14, 2009
Its Worse Than I Thought...
A particularly interesting entry on a very interesting website for China watchers: