As I've explained in detail over the years this is what FED was doing in the late '70s :
SHANGHAI, Dec 20 (Reuters) - Chinese money rates spiked for a third day on Friday to their highest since a massive cash crunch in June despite regulators' efforts to steady the market, raising fears that another liquidity squeeze was underway and driving mainland stocks sharply lower.
The stresses in the interbank market highlighted the difficulty regulators are having in gradually raising the cost of short-term credit to rein in speculative forms of finance without setting off destabilising spikes in adjacent markets.,
Interventionism.
They also reflected a more fundamental problem within the world's second-largest economy: poor communication by a central bank accustomed to manipulating the cash supply from behind the scenes.
"We believe the PBOC is faced with some serious challenges with rapid unfolding of bottom-up interest rate liberalization and is confused on whether to target volume or rates (prices) of liquidity," wrote Lu Ting, an economist at Bank of America Merrill Lynch.
That's just it. The CB either targets money growth, rates, or neither, but it can't do what FED tries to do, hide behind Congress created Dual Mandate and,in effect, target rates and supply simultaneously. This action embeds unknown instabilities which erupt into financial crises. You cannot interfere with the market's need to clear by randomly fluctuating to whatever level it will.
"With its limited predictability of flows and its insensitivity to market reactions, the PBOC finds it much more likely than before to make operation mistakes."
The benchmark seven-day bond repurchase contract began rising on Wednesday, and the rise accelerated when the People's Bank of China refrained from injecting cash into the system during regularly scheduled open market operations on Thursday, the fifth straight session it stayed on the sidelines.
The PBOC, as is usual, gave no comment or explanation for its decision, but when money rates leaped up on Thursday in reaction, it attempted to calm sentiment by issuing a statement that it would support the market with short-term liquidity operations (SLOs). In fact, it said it had already done so, and extended trading hours by 30 minutes to give dealers more time to settle transactions.
Throwing gasoline on the fire. By the way, Volcker wasn't the one who chose to stop FED from doing this in late '79. He resisted it. Thought it would cause a depression because FED had no idea how high rates needed to go to reach equilibrium. It is this intrinsic not knowing that causes all the problems. That's why in a free market ones does not fix price, i.e., target anything.
China Business News, a newspaper owned by the Shanghai municipal government, reported on Friday morning that the bank had injected 200 billion yuan ($33 billion) through SLOs with selected banks, quoting an unnamed banking source.
"If it's true what everybody is saying, that the bank injected 200 billion yuan yesterday through a short-term liquidity operation, and this wasn't enough to fill the hole, it must be enormous," said a trader at an Asian bank in Shanghai.
STOCKS, COMMODITIES HIT
In addition, SLOs in China are conducted with individual banks behind closed doors and the PBOC statement cast little light: It did not say how much money it had injected using the SLO, to whom the cash was given, or even the day on which it was executed.
As a result, dealers shrugged off the message and pushed rates up again on Friday.
The interest-rate swap based on the benchmark seven day repo , considered the best indicator of liquidity conditions, remained near the record high of 4.99 percent struck on Thursday. The seven-day repo average rate also rose to close above 8 percent, the highest level since June 21 and within range of the all-time high of 11.6217 percent hit June 20.
The anxiety infected the stock market, where rumours were beginning to swirl of loan defaults by commercial banks. The CSI300 Index, which tracks the largest listed firms in Shanghai and Shenzhen, slid 2.3 percent on the day and lost 5.3 percent for the week, its worst weekly performance since late February.
China is planning to relaunch initial public offerings next year after keeping them on hold for more than a year, part of a push to provide Chinese firms alternatives to bank loans, but the prospect of more stock market volatility could damage already-rocky investor confidence.
Demand for commodities was also hit, with spot copper premiums for bonded stocks dropping more than 10 percent this week. Demand for other base metals, including zinc and aluminium, has also weakened due to the cash crunch, trade sources said.
FURTHER SHOCKS
Some say further shocks are likely in the future unless the PBOC tweaks its current strategy for attacking the way China borrows, lends and prices capital.
Regulators were startled earlier in 2013 when the "shadow banking" sector began to post explosive growth, driven in particular by high-yielding wealth-management products and more obscure instruments like discounted bankers acceptance notes.
Economists argued that this growth was largely being used for speculative purposes - or alternatively to roll over bad local government debt - and regulators quickly cracked down, both through administrative measures and by increasing the cost of short-term money in the interbank market.
But at the same time it left long-term rates untouched, neither raising official deposit rates nor increasing reserve requirement ratios, both of which would suck long-term base money out of the system - with a likely impact on the ordinary lending that drives healthy economic growth.
So far this has been successful: long-term lending rates remain stable, and Chinese economic indicators have posted encouraging signs of recovery, even while growth in shadow banking has eased.
But although the June cash crunch prompted the PBOC to promise publicly to be more transparent in the way it manages the money supply, so far traders say there has been little follow-through.
"The central bank doesn't need to explain itself to anybody," said a trader at a joint-stock bank in Shanghai. (Additional reporting by Chen Yixin and Fayen Wong; Editing by Chris Gallagher) |
