The PBoC's Extraordinary Intervention
The renminbi’s managed peg against the dollar is one of the cornerstones of Chinese economic policy. Typically, maintaining such a peg in the face of significant pressure to appreciate would be extremely difficult.
The People's Bank of China (PBoC) is forced to print large quantities of renminbi and buy up dollars in order to combat the forces driving up the renminbi’s value.
This increase in the quantity of renminbi would normally lead to increased inflation in China. However, the PBoC avoids this by storing away excess renminbi through monetary policy instruments such as central bank bills and the required reserve ratio.
China’s foreign exchange reserves, built up through exchanging renminbi for foreign currency with Chinese exporters, are one indication of the scale of intervention.
Another approach is to look at how much renminbi has been locked away as part of the sterilization policy.
As you can see, sterilization liabilities are now approaching 50% of GDP, with PBoC required to pay interest on these reserves. Going forward, any policy to unwind sterilization intervention will have to take into account the effects of freeing up this massive pool of money on inflation.
Another indicator of heightened intervention is the stratospheric leverage (Liabilities:Own Capital) of the PBoCs balance sheet. While central banks are not bound by the normal leverage restrictions that bind regular banks (they can always print money if they need to), the PBoC has leveraged itself up to an unprecedented level.
The PBoC’s leverage ratio is now greater than 1250:1. Just for a little context, the Federal Reserve came under severe criticism last year when its leverage ratio hit an all time high of 49:1.
The PBoC asset's have also grown significantly, reaching over 65% of GDP.
It's no wonder that many have reported that the PBoC is an advocate for continued currency appreciation. It's two goals, maintaining price stability and preventing an appreciation of the renminbi, are conflicting. Moreover, maintaining the balance between the two has become increasingly difficult given the renminbi's undervaluation. The PBoC has forced to undertake extraordinary interventions in the economy and in the process has created a situation that will be difficult to unwind without significantly worsening inflation.