Investors, watch the People's Bank of China!

At 31 trillion renminbi the People’s Bank of China (PBOC) is now the largest central bank in the world by some margin.  It also operates differently to other banks in one crucial respect - it sets domestic banks overnight reserve targets rather than operating through reserve maintenance windows which allow some flexibility.  This gives it more direct control over domestic credit, as can be seen by the fact that over the last 40 years the credit multiplier (ie. the ratio between the total pool of credit, including shadow banks, and the PBOC’s balance sheet) has remained almost unchanged at about five times.  In contrast, both the US and the Eurozone’s equivalent numbers have varied by about 400%, demonstrating that the Federal and the Reserve and the ECB have more limited control over their economies.


An important consequence of this is that interest rates and bond yields, which we have always seen as the ‘price’ of money’ rather than a policy tool anyway, do not give any signals about the PBOC’s policy stance.  The clearest signal of domestic monetary policy is given simply by the size of the balance sheet.


In 2015, there was a 15% tightening, both in order to ensure the Chinese currency was included in the IMF’s SDR basket and also as part of an anti-corruption drive.  This resulted in a sharp contraction in the economic growth rate, capital outflows, and sharp falls in equity markets both in China and other Emerging Markets.   


Today the balance sheet is growing at a 12% annualised rate.  In our view, this is clear evidence of easier monetary policy, which will in turn lead to a faster growing Chinese economy.  As well as Chinese markets, other Emerging Markets and Japan and commodity prices can be expected to benefit.  


Some commentators are misled by rising bond yields, currently 4%, believing this is a signal of tighter monetary policy and a faltering economy.  In contrast, we see this simply as a higher ‘price’ of money as economic confidence returns and appetite for safe assets declines.


It is not all good news: if the PBOC has more control over its domestic economy than western banks, it has the ability to turn the taps off as well as on.  The next major financial crisis may well emanate from this source.  That is why we say all investors need to watch the Chinese central bank.


Our data comes from our friends at CrossBorder Capital, who have published a more detailed analysis on this subject and have for many years kept a careful eye on Chinese monetary policy.  If you would like to purchase their report, please email us on