What the US Can Learn from China’s Monetary Policy
Its no secret that China is pulling all stops in an attempt to slow or thwart an oncoming asset bubble in real estate as well as the stock market. Most recently, China moved swiftly to raise the reserve ratio at lending banks in an effort to lower the money supply ceiling.
Reserve Ratios are Critical
For any fractional reserve system there is no variable as important as the reserve ratio, or the amount of money banks and lending institutions must set aside for bad loans. This ratio isn’t just important because it forces banks to have a backup plan in case of default but rather to create an artificial ceiling for the money supply and to restrict the Money Multiplier. China now has one of the loftiest reserve requirements in the world at a rock solid 16% for small banking institutions and 14% for their larger counterparts. This is after the recent adjustment of .5%.
Does .5% Really Matter?
When it comes to interest rate policy, .5% is virtually meaningless as it pertains to extending, or protecting a bubble. However, when it comes to reserve requirements, a .5% change ultimately means the money supply can grow by 3.5%-5% less than its previous maximum. This is huge, practically limiting inflation and promoting growth in the true physical economy.
Analyst Predictions
Analysts are now predicting that China will force its reserve requirement as high as 18%, keeping the money multiplier at roughly 5.5 times the physical money supply. These numbers mean nothing until you compare them to say the United States which has a reserve requirement of 10% and allows for the creation of 10x M1 money supply in the M3 Money Supply. This tightening of the amount of available credit is sure to create shockwaves through the country but its certain that should China move to 18%, all chance at a bubble will have been avoided.
