Too Many Yuan

Interesting news from China today, via the Wall Street Journal:

SHANGHAI -- China's central bank said it plans to absorb about $20 billion in cash in its latest effort to keep its economy from overheating. The move is meant to rein in lending without raising interest rates and to reduce liquidity in the country's financial system.

The People's Bank of China said Friday it plans to sell banks about 160 billion yuan, or $20.45 billion, of one-year bills in the yuan money markets today. The bills will yield 2.7961%. By placing the debt instruments with commercial banks, Beijing is reducing the amount of money banks have available to lend.

...China's government is concerned too much cash in bank coffers will encourage bankers to boost lending. The risk of too much lending is either inflation, as the lending sparks economic growth, or losses for banks if the loans go bad. The buildup of cash comes from China's exports, which are pulling dollars into the Chinese financial system. Exporters then spend their earnings after converting their money into yuan.

In a sense, this is not a dramatic change for the PBOC; it has been issuing "sterilization bonds" for years in order to mop up some of the extra yuan generated by its actions to keep the currency pegged against the dollar.

But in another sense, this news is quite interesting. That's because a bond issue of this size indicates that the financial pressure may be building on the PBOC to use the next obvious tool that would reduce the amount of yuan floating around in the Chinese economy: to allow the yuan to appreciate faster against the US dollar. I'm sure that there is quite a bit of ongoing discussion about this very subject within the halls of the PBOC...