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Cathartic monetary disorder, Part III

In the part 2 I was discussing the dollar peg. Today the topic is the dollar sterilization. How does sterilization work? In order to avoid excessive inflation Chinese dollar asset purchases must be sterilized. It is done by increasing bank reserve requirements and issuing special Yuan-denominated bonds with interest close to the interest of US Treasuries. This rate is far below the market rate. Mish is reporting that a woman who invested her savings into a loan shark fund is paid a 30% rate by property speculators . Banks that are being stuffed with those low-yielding bonds feel over-protected and are willing to take excessive risk elsewhere. Here are some numbers to illustrate sterilization. As of October, the PBOC was selling 1y Yuan denominated bonds at 2.09% while purchasing identical maturity Treasuries at 0.21%. Obviously it cannot work indefinitely. The sterilization is bloating the People’s Bank of China’s balance sheet. As reported here it is already at 68% of GDP, several times over what is typical for a western CB. All the assets are in foreign currencies while liabilities are in underpriced yuan. One guest at Bloomberg caclulated that it was sufficient for the yuan to appreciate just by 3% […]

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