Martin Feldstein‘s article on the WSJ today, “The Fed should start to ‘taper’ now” puts the whole Fed’s to-taper-or-not-to-taper debate very succinctly. It is not about recovery or the lack of enough recovery of the US economy. It is about the growing distortions in the US market place caused by reckless risk-taking in this extended low-rates environment. Mr Feldstein’s point is that this has blunted the efficacy of QE such that it no longer justifies these “side effects”.
Now if you think about it, this is the very same reason why China is starting to do what it is doing – cleaning up “shadow banking”. This phrase contains two important words – “shadow” which means something lurks in the background that no one monitors nor regulates; and “banking” which refers to deposit-taking on one hand in order to support loan-making on the other. Put together it literally means pawn shops have become banks unmonitored and regulated. Yes, the effect of cleaning up shadow banking by the PBOC would amount to the same as the Fed tapering QE. China’s shadow banking is close to 40% of the size of the Chinese economy. The Fed’s QE cumulative purchases stand at about 12% of the US GDP. Amid cleaning up shadow banking, Chinese policymakers clearly hopes the traditional banking takes over some of the better businesses – so of course you won’t need to worry that money equivalent 40% of GDP would be totally wiped out. In Fed’s case, they are tapering i.e. stopping more QE but eventually all outstanding QE purchases must eventually be unwound.
Next question – how does the PBOC’s shadow QE – well, if as a central bank you have not curtailed a pawn shop from “creating money”, that’s akin to QE – impact on the rest of the world? Plenty of ways – first, it fuels the spending power i.e. importing power of China; and second, it leaks money into the growing global offshore deliverable CNY market. So we all must have been unknowingly benefiting from China’s shadow QE.
I guess the subtle difference between the Fed’s QE and the PBOC’s shadow QE is that the former landed mostly into the global fixed income market while the latter landed mostly into the global commodity market. This is why when a Reuters reporter called me up this morning to discuss about the impact of Fed tapering on us, he asked “what else” have we not thought about – I said commodities. There are also supply side wild cards that most people do not diligently follow – the phasing out of nuclear power in a number of countries starting with Japan and Germany and the coming of shale gas exports from the US from around 2014-15; and the implications of all these on the shipping routes globally that could also affect Asia’s entrepot trade, not just merely on the Asian consumer’s price basket.