The signals coming from Beijing about the yuan have been mixed. Who should investors listen to? Whoever ranks highest in the party. That’s not the central bank.
Western economists like the People’s Bank of China, in part because many of its officials are trained in conventional monetary economics. But inside the government’s complex hierarchy, the situation is quite different.
In the official list of the 28 ministries which sit under the State Council, the PBOC is ranked 27th, just after the National Population and Family Planning Commission and ahead only of the National Audit Office. The central bank is four seats behind the pro-export, anti-currency appreciation Commerce Ministry. And there are reasons to believe that even the State Council is not the final authority for a decision as significant as de-pegging the yuan. That will be made by the Communist Party’s nine-member Politburo Standing Committee.
Investors should listen closely to Premier Wen Jiabao, head of the State Council and member of the Politburo Standing Committee. Wen said on March 14 that he doesn’t believe the yuan is undervalued and called U.S. demands to revalue protectionist. He vowed Beijing will steer its own way on currency reform.
The top party leaders probably haven’t heard of the Balassa-Samuelson effect, which explains that currencies rise as countries get richer. In fact they are more inclined to believe that yen’s sharp appreciation after the Plaza Accord is the culprit for two decades of slow Japanese growth.
The PBOC may be equally powerless when it comes to the policy interest rate. Some say that higher authorities actually make the call. But really, in a country where capital can’t move fast, the price of the money doesn’t matter much.
The central bank does set loan quotas for banks and gives them advice on who should get loans. But even on these matters it shares that power with the banking regulator. As the Chinese economy evolves, the central bank may become more important. For now, though, it is largely, in Chairman Mao’s phrase, a paper tiger.