In the face of an unwavering adherence by the US to highly accommodative policies, China is faced with the prospect of recycling its ever growing FX reserves into nations or regions that it probably has fundamental fiscal concerns about.
This brings me to the simple observation that the only meaningful way for China to deal with this problem is to change policy so that it doesn’t need to intervene on a daily basis (and, hence, accumulate fresh FX reserves that require recycling).
Given this, recent comments from senior officials at the State Administration of Foreign Exchange are of real interest.
On April 27 Li Chao, a deputy governor at SAFE, told the China Securities Journal that in the long run China can only tackle its excess money problem by liberalizing its capital account and allowing cash to flow out, a process that should be sped up by reforming the yuan to make it convertible.
On the same day his colleague Sun Lujun, director general of the capital department of SAFE, argued that China's economic development had reached a stage where it was no longer necessary to maintain an old policy that encouraged foreign capital inflows but restricted fund outflows. He also said that China aimed to gradually ease capital controls and promote yuan convertibility.
This week also saw a telling comment emerge from Guan Tao, head of SAFE’s international balance of payments department. In an essay published on the China Finance 40 Forum's website, he argued that allowing the yuan to float "doesn't necessarily mean the yuan will appreciate one way” and would help to contain one-way speculation. Moreover, market participants would automatically adjust their business activities to adapt to a floating system.
Concrete evidence that the topic has been raised at official levels emerged on May 3 when the Wall Street Journal published an interview with Huang Yiping, an economist at Peking University's China Macroeconomic Research Centre, arguing the case for what he called a “conditional free float."
His reasoning was simple. He noted that China's $3 trillion in foreign reserves meant "we're lending money to lots of countries and getting very low returns. I don't know if we can preserve the value [of the reserves], and there is no alternative to [investing in] the USD." He also noted that letting the currency float would also end the Peoples Bank of China’s (PBOC) need to "sterilize" the inflow of US dollars by issuing bonds in yuan.
Mr. Huang also told the Journal that he had presented his ideas to the PBOC, Ministry of Finance and National Development and Reform Commission. He specifically noted that PBOC officials were sympathetic to his ideas, but that "the key issue isn't whether the PBOC agrees. The issue is whether top leaders agree."
Some idea of the advice that the most senior members of the Chinese government might be receiving on this matter emerged a few days later in a front page report in The China Daily. It quoted Chen Daofu, the policy research chief at the Financial Research Institute of the State Council's Development Research Centre, as saying that the time wasn't right to allow the yuan to float freely given the excessive liquidity caused by the FOMC’s quantitative easing policy.
However, he also stated that China should speed up allowing full convertibility of the yuan in trade and direct investment. In other words, at least one figure in the Cabinet’s advisory body believes that the pace of liberalization needs to pick up significantly.
Given that the interaction of US monetary policy and Chinese currency policy has been one of the defining forces for the currency markets over the past decade, this developing story needs to be tracked closely.
Simon Derrick is head of the currency strategy team at Bank of New York Mellon