While the Fed has no ‘guts’, the PBOC is on steroids

It is debatable whether the US Federal Reserve has sense, vision or “guts”. But one thing is certain: The US central bank has become a weakling. The People’s Bank of China, on the other hand, is loaded with technocrats on steroids.

The Fed’s prestige took a hit recently. Its most powerful regional reserve bank somehow botched a critical market rescue operation — its first overnight repurchase agreement operation in a decade. Monitoring supply and demand in this key funding market should be routine; yet, embarrassingly, the Fed’s main rate shot above its targeted range, just when central bank officials were convening for their monetary policy meeting. The New York Fed will follow up its US$75 billion ($103 billion) emergency liquidity injection with another equally sized chunk on Sept 19.

By contrast, open-market operations have become commonplace for China’s central bank, which actively manages liquidity to its liking. That is less a signal of the PBOC’s draconian grip on the market and more indicative of its increasingly sophisticated efforts to ensure things run smoothly. Since a funding crunch in January 2016, the PBOC has given itself the flexibility to conduct such operations on a daily basis, up from twice a week. There are 49 primary dealers, mostly banks, that carry out the central bank’s bidding.

These procedures help the PBOC manage foreseeable renminbi shortages in the money market. For example, on Jan 16, the central bank injected a net RMB560 billion ($109 billion), the highest on record, into the interbank system via reverse repos to meet consumers’ demand for renminbi ahead of the Lunar New Year, when cash gifts are common.

The PBOC also is not shy about experimenting. Of course, there are the traditional tools: repurchase agreements and reverse repos, which, respectively, drain and inject short-term liquidity into the banks. Yet, clever policymakers keep inventing new toys. Last December, the PBOC launched targeted medium-term lending facilities to encourage banks to lend to small businesses. In January, officials introduced central bank bill swaps to help lenders replenish capital by issuing perpetual bonds.

The PBOC also uses open-market operations to manage the yield curve, which in China remains relatively steep compared with other global markets. Since the central bank has been cutting reserve ratios its commercial banks are required to hold — to encourage more lending to businesses — it has simultaneously been retiring medium-term lending facilities, effectively dialling up one knob and dialling down another. This ensures that rates in certain parts of the curve do not drop too low.

Wall Street analysts have been calling for the PBOC to cut its benchmark oneyear lending rate since early 2019. So far, the central bank has resisted. That is all for good reason, as I have written. The PBOC has realised that a good chunk of blanket easing goes into the real-estate market, which makes China’s housing unaffordable to the middle class and risks stoking social unrest.

One can scoff at more obscure open-market operations, saying they are insufficient to avert an economic recession. But here is the thing: If a central bank is getting a good read on the economy by engaging consistently with traders, it can send liquidity to pockets of the economy most in need. Rate cuts then become a last resort. That is a problem the Fed can only dream of having. — E