This is a repost; originally published on Dec. 22, 2016.

On April 27, 2007, the People’s Bank of China announced that it was raising the statutory ratio for required reserves by 50 bps to 11%. The Chinese had allowed their currency exchange rate to moderately float almost two years earlier, which changed the way monetary policy would have to work. Without full control of “capital” moving in and out (far more the former), the country’s monetary system would be at issue where external “inflows” could heavily influence internal liquidity, thus inflation, thus overall economy.

Starting in July 2006, the PBOC had begun to raise the Required Reserves Rate (RRR) not necessarily to “tighten” as it might be understood under Western conditions, but rather to shift its influence from strictly CNY. The level of RRR does not control the amount of money or even deposits, as that is still a matter of this external/internal balance. In other words, money growth would still be very strong based on “inflows”, only now the PBOC would attempt to restrain credit growth no matter how much “hot money” moved in.

And in early 2007 it was again “too” strong. On April 27 that year, the PBOC published the new requirement to be effective May 15. Only three days later, on May 18, the PBOC declared yet another 50 bps hike in the RRR. This would continue throughout the rest of the year, where on December 8, 2007, the PBOC raised the RRR for the tenth time in that one single year, this time by 1% effective December 25.

It made for an interesting dichotomy certainly with the United States and the Federal Reserve. Here, monetary officials were struggling with the opposite conditions, if only in certain parts. The banking system was increasingly illiquid, yet oil prices and inflation were running through the roof. The Fed throughout the middle of 2007, at least, didn’t know whether to resume “tightening” or start more “accommodation.” They chose the latter, though only theoretical, as subprime proved far from contained.

I devote a great deal of time and effort on China and its money in particular which to some may seem curious, a sort of niche interest. Economically-speaking, there is no explanation necessary for expending resources analyzing the Chinese economy given its size and prominence as an outlet for global growth. Thus, any outsized interest in its monetary conditions could seem relevant to that task. But my view on China money is that it is more than China, perhaps the least ambiguous indication we have closer to real-time for the “dollar.”

But as the diverging fates of monetary policy China to the US in 2007 showed, we always have to be careful because there is no singular “dollar”; there are only pieces and fragments that can perform as if entirely unrelated until they are reconciled with the whole usually under the worst conditions. The internals of the global US$ MBS system and many pieces related to it, including repo, were falling apart, but others that were more outwardly related were acting as if turbocharged.

That latter segment included, of course, oil and other commodities like copper. Though we can never know for sure the actual points of distinction, the eurodollar system as a whole developed first overseas in order to finance global trade exclusively. It was only later especially after 1995 when these eurodollar capacities began to “leak” inside the US to finance things like mortgages and consumer credit. Systemically speaking, then, it perhaps should not have been surprising to see the portion devoted to financial arrangements including those related to the housing bubble in the US implode as an almost totally separate matter from what “we” still call “hot money” funding all those EM growth “miracles” as if there really had been a “global savings glut.”

This difference very much echoed emerging economic thought at the time, where the word “decoupling” made its first appearance as worries about the US economy were cauterized by this seeming split in finance (really “dollar”) as well as economy. Without understanding and appreciating eurodollars, it really did look as if the US was alone in its trouble. Not only were the Chinese still raising their RRR to further tame “inflows” largely “dollars”, lest we forget the Europeans were raising rates, too, in early 2008.

What exactly happened in mid-July 2008 likewise will probably never be known, though it was surely related to the GSE’s (and there will always be nagging doubts about IndyMac and a couple other minor developments) and how that might have triggered a system revolt in the math – both “parts” of it this time.

In China, they went from one month dealing with the ongoing huge surge of “hot money” to suddenly worrying about full-blown internal monetary contraction. It was as if someone had flipped the “dollar” switch. Rather than risk further damage as the CNY rate would very likely have started to reverse, the PBOC resumed pegging the exchange rate to the dollar in what has become a very familiar process, though still couched euphemistically as “selling UST’s.”

As you can see on the chart immediately above, the more they pegged CNY the greater the internal illiquidity, leading to several cuts in the RRR later in 2008. Both directions established, we see also very plainly that the CNY rate is a quite good proxy for the “dollar”, or at least some part of it, whether that be an Asian “dollar” or something even more specific.

These relationships continued on the other side of 2008, too, where in the initial “recovery”, or the times when it looked like it might turn into one, it was as if 2007 all over again. The PBOC began to raise the RRR in the middle of January 2010, a full five months before they finally let go of the CNY peg again. We can easily assume that was the resumption of private “dollar” flow alongside the PBOC’s continued “selling UST’s” that also supplied “dollars.”

Though Chinese monetary policy restoration in the RRR paused after the “unexpected” resumption of trouble in May 2010 with the “flash crash” and sudden interest in Greece, Bernanke’s QE2 later in the year pushed “dollar” flows back to the extreme (not because of the bank reserves created by QE, instead due to bank balance sheet retracement due to expectations of its effects in the real economy and on volatility). Just like May 2007, in November 2010 the PBOC raised the RRR one day (November 16, less than two weeks after QE2 had officially been announced) and announced the next 50 bps hike just three days later.

The RRR hikes continued until the sudden re-appearance of global, unified eurodollar problems all over again in July 2011. The RRR was reduced importantly in the first half of 2012 (starting December 2011), just as the global economy slowed and has yet to recovery. Similarly, the RRR has been only lower ever since, as have, it should be pointed out, commodity prices in general. It demonstrates that the RRR is not really about “tight” or “loose” monetary policy in China, as it is so often described, rather it is an indication of this external/internal balance of “dollar” money and Chinese monetary responses to it.

It demonstrates pretty conclusively that the traditional standing on global money is false; hot money, outflows, the ridiculous global savings glut, etc. There is instead a global monetary system, denominated in dollars, that is bigger than any single central bank including the Federal Reserve. It may not be a monolithic mass, but it can act that way at times such as the second half of 2008 as well as 2015.