Monday, November 5, 2012

Data visualization: The People's Bank of China balance sheet

David Glasner and Scott Sumner have posts on Chinese monetary policy. They both inquire about the People's Bank of China (PBoC) balance sheet. I've affixed a chart of it below.

Here's a quick rundown of how the PBoC balance sheet changes. The PBoC sets the yuan-to-dollar exchange rate at some rate below what it would in a free market. Chinese exporters thereby enjoy a subsidy. The law requires that the foreign currency that exporters earn overseas be repatriated and exchanged for yuan. The PBoC prints yuan (bottom green area) or provides deposits (bottom purple area), receiving this foreign exchange in return (top green area).

(scribd pdf)

By creating such large quantities of liquid currency and reserves, the PBoC will force the domestic price level  to rise. In order to prevent this inflation, the Bank must "sterilize", or mop up the liquidity it has created. It does this by issuing bonds (dark blue area at bottom) to domestic banks in exchange for currency and reserves (bottom purple and green). Thus liquid instruments are replaced by an illiquid instrument, bonds. The PBoC also forces banks to hold large quantities of required reserves (bottom purple area), which immobilizes what would otherwise be a fairly liquid instrument. In this way the rise in the domestic price level can be temporarily prevented. The PBoC could also sterilize by selling domestic assets (top pink, blue, or yellow areas) and retiring the currency and reserves it receives. But given that domestic assets held on the PBoC balance sheet haven't changed much over the years, it's likely that different means are being found to sterilize.


  1. From 2002 to 2012, the chinese price level rose from 93 to 122, while your chart shows paper money and deposits of financial institutions rising by multiples of that. Sounds like PBoC money might be backed by PBoC assets!

  2. Here's the riddle. If one accepts the fact that the PBoC is undervaluing its currency, then it is effectively purchasing assets at too high of a price. So why aren't its liabilities decreasing in value at a faster rate?

    1. Two answers:
      1) If it is overpaying, but we don't know by how much, then for all we know the liabilities are falling in value at exactly the rate that the loss of assets implies.
      2) A bank with positive net worth can lose lots of assets without affecting the value of its currency. (The currency is, after all, a first and paramount lien on the bank's assets.) But a bank with positive net worth can still make its currency lose value just by reducing the rate at which it will buy back its currency.

      Dang! That spam filter of yours keeps locking me out!

    2. Sorry about that Mike. Is the filter really worse at my blog than at other blogger sites?

      Those answers make sense to me. Another one is:

      3) Even though its overpaying for forex assets, when it retires yuan deposits and currency through sterilization, it is underpaying for those yuan. So the full round-trip results in a wash. Most people believe that the PBoC not only forces its banks to subscribe to sterilization bonds, but makes them do so at bad rates. Financial repression, so to say.

  3. Yup, your spam filter is definitely tougher than average. On the other hand you are definitely the KING of data visualization.

    I'm still thinking about your answer #3

  4. OK. #3 makes sense to me now.

    BTW: I mentioned your name in a comment over at Uneasy Money. I'm hoping you might weigh in over there.