Beijing's Next Moves in Monetary Policy

by: Stephen Jen

Morgan Stanley economist Stephen Jen explains why he thinks Beijing will change gears in USD/CNY policy in the second half of the year. Below is an excerpt from his thesis:

For China, managing more than US$1 trillion of reserves (China’s official reserves reached US$941 billion at end-June, and are on track to breach the US$1 trillion mark by September) would not be easy. The marginal benefits of having a large pool of liquid foreign assets to meet speculative pressures are increasingly overwhelmed by the marginal costs of an official entity being exposed to so much financial and political risk. In other words, assets of this kind, if they are too large, become liabilities in some sense.

...Holding USD/CNY at such a high level now will itself discourage outflows simply because Chinese investors with genuine interest in investing overseas may be concerned about potential capital losses from future CNY appreciation. In short, the more USD/CNY trades toward its fair value, which is less than 10% from the current spot rate, the more likely it is for capital outflows to take place, in my view.

...With the US running at above potential growth rate, and the unemployment rate being so low, protectionism has remained a key risk, and a main worry for the US Treasury. If the US slows, it is likely that this risk of protectionism could gain considerable political momentum. In my opinion, China should use the CNY as an ‘insurance’ against this risk of protectionism.

See Jen's full analysis.