This morning the Chinese central bank lifted the reserve requirement for banks another 50 basis points to a record 20% in order to curb speculation. The Chinese have been forced to tighten monetary policy due to inflation concerns and growing signs of extreme levels of commodity speculation. Last month I posted a video showing a Chinese farmer engaged in an extreme form of cotton hoarding. This past week, FT Alphaville’s Iza Kaminska also demonstrated that Chinese speculators have been using copper as collateral for financing deals. These are but two signs of the kinds of animal spirits now at work in China.
The Chinese have also started to raise interest rates this year but have not accelerated the pace of currency revaluation. My sense is that once these kinds of animal spirits become entrenched, they are hard to dislodge. This was the Greenspan conundrum from the middle of last decade as the Fed slowly raised rates. Long-term rates continued to decline even so. Fed officials have pointed to an Asian savings glut to explain this ‘conundrum’, something I have dubbed the Blame Asia meme. The reality is that speculators do not see themselves as speculators; they see themselves as investors. And as such, they have long-term financial positions which they are prepared to defend when the central bank comes in with a mini-tightening. It will take far more aggressive action to stop credit excesses once animal spirits are well advanced.
I agree with Ray Dalio when he says:
The one world is booming. The emerging market. Inflation rates and strong growth rate and tied through this currency link to the U.S., Europe and Japan. And as a result, they have totally inappropriate monetary policies because if you have a currency that’s linked, you have interest rates that are linked. And it’s created totally uneconomic behaviour in those countries. This is going to be the big next seismic shift, I believe. I think that probably something in 2012 it will become intolerable to maintain those currency links and we’ll probably have a big shift.
–Another conversation with Bridgewater Associates’ Ray Dalio
The shift in policy is already underway. But it is not nearly aggressive enough yet. China will find it needs to get much more aggressive. And the question then is whether they can engineer a soft landing.