Download Conflicted Virtue

Why would China NOT have
Liquidity Trap Under Conflicted
Virtue?
Shuang Ni
Yuze Chen
Zidao Wang
Conflicted Virtue
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Any international creditor country that cannot lend
in its own currency cumulates a currency mismatch
that we call the syndrome of conflicted virtue.
Countries that are “virtuous” by having a high
saving rate tend to run surpluses in the current
account of their international balance of payments
Conflicted Virtue
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1. As the stock of dollar claims cumulates,
domestic holders of dollar assets worry more about
a self-sustaining run into the domestic currency
forcing an appreciation.
2. Foreigners start complaining that the country’s
ongoing flow of trade surpluses is unfair and the
result of having an undervalued currency.
---Deflation and Liquidity Trap
---Trade Sanctions
CV in Japan
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After the WW II Japan has a large trade surpluses
with the US.
The trade friction become more and more serious
between Japan and US.
The US want to reduce the trade deficit by
influence the exchange rate.
----<Plaza Accord>
Zero Interest Rate and Liquidity Trap
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The interest rate parity relationship
i = i* + Δse +φ
i is the Japan interest rate
i* is the US interest rate
Δse is expected depreciation of the yan, ≈0
Φ is the risk premiun on yan assets
 φ is negative for a creditor country such as Japan
with private sector assets denominated in foreign
currency
Zero Interest Rate and Liquidity Trap
How About China?
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China is second largest nominal GDP country
China has a large amount of trade surplus
with US, 318 billion dollars in 2013, 315
billion in 2012.
China is largest US Debt foreign holder, its
holding of $1.2 trillion.
So, China also faces the Conflicted Virtue
issue
Does China Occur the Liquidity Trap?
NO
Why?
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Compare to Japan, China can deal with the
appreciation pressure from US.
In 1980s, Japan had to appreciate yen under
the pressure from US because of the politic
issue.
Stable Exchange Rate
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The Exchange Rate Regime
Appreciation Pressure
Continue
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US’s Quantitative Easing (QE) Policy make
yuan appreciate after 2007.
QE1 in 2008, QE2 and QE3 in2010, QE4 in
2012.
However, US announced stop QE in 2013.
So China succeeds to stabilize its exchange
rate.
Chinese Official Foreign Reserves
3,500,000,000,000.00
3,000,000,000,000.00
2,500,000,000,000.00
2,000,000,000,000.00
Chinese Official Foreign Reserves
1,500,000,000,000.00
1,000,000,000,000.00
500,000,000,000.00
0.00
2004
2005
2006
2007
2008
2009
2010
2011
2012
China: Current Account and Net FDI inflows
Japan: Current Account and Net FDI inflows
China's Cumulative Surpluses on Current Account,
Trade, and Net Foreign Direct Investment
Nowadays China
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has benefited enormously from the massive
FDI inflows
largely in joint ventures with domestic
enterprises
have accelerated its access to modern
technology
faces the “conflicted virtue” ?
Suggestions by Ronald McKinnon
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take policy measures to reduce—and even
reverse—its current-account surplus
reduce the financial magnitude of the FDI
inflows by letting joint ventures finance more
of their operations within China
push vigorously in expanding aggregate
demand domestically
Short term
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People’s Bank of China (PBC) must intervene in
the foreign exchange market to buy the excess
dollars
Not sterilizing these interventions relieves the
pressure
As long as interest rates on renminbi assets
remain well above zero, such increases in the
monetary base could be effective in expanding
the domestic economy while slowing the growth
of official exchange reserves.
Shortage of McKinnon Opinion
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Professor McKinnon missed a very important
part in his report: Duality of Chinese
Economy
China is a duality economy
Official Sector and Unofficial Sector
Duality of Chinese Economy
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Official Sector: Data in Government official
institutions.
Unofficial Sector: Shadow Banking System
Shadow Banking System
Collection of non-bank financial intermediaries that
provide services similar to traditional commercial
banks.
 The difference between official and Shadow
banking lending cycle is the Reserve Requirement
Ratio(RRR)
---For China’s Major banks RRR is 20%
---For Shadow Banking System is 0
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Shadow Banking System
From the graphic we can see with the 0%RRR the fund can create the highest
extra credit.
So in China the shadow banking system will be more efficiency, liquidity for
investors and borrowers.
How large of Shadow Banking
System
The size of Shadow Banking System is hard to
estimate, because it is unofficial or shadow
 The estimate report from some financial institution:
-J.P Morgan: Nearly to $6 trillion, or about 70% of
China’s GDP
- Chinese Academy of Social Sciences: the size is
equal to 40% of China’s GDP
-ANZ Bank: About $2 – 3 trillion, and equal
to
1/3 of China’s GDP.
Conclusion: Even if there are differences in their
estimated, however, we can know the size of Shadow
Banking System or unofficial sector is large in
China’s financial market.
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Why it is too Large?
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Japan has a very small size of Unofficial Sector
Because Japan has a developed financial
system, and government can control its
domestic financial market, therefore, the
businessman or citizen is hard to touch with
Shadow Banking System
But China is completely different, the
underdeveloped financial system make
government hard to control it, so Shadow
Banking system can develop rapidly in China
financial market.
Conclusion of Unofficial Sector
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As for China’s Official Sector, there is conflicted
virtue issue and China face the liquidity trap
However, in Unofficial Sector, the large size of
Unofficial Sector will not let China face the
liquidity trap, because the interest rate cannot
be fallen in unofficial sector
Therefore, R. McKinnon did not analyze China’s
Unofficial Sector, because China’s financial
system is different with other countries, and the
size of Unofficial Sector is very large compare to
other countries.
Thanks For Watching!
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