FT Alphaville " That's Governor Zhou to you That's pronounced a bit like "Joe," but with a softer "g" sound. According to Standard Chartered you need to start practising - because People's Bank of China governor Zhou Xiaochuan is "the world's central banker." StanChart note that everyone already knows China has the world's largest stock of M2 money. But what they think is more important in the Zhou era is China's importance as a creator of new M2: According to our calculations, China was responsible for 52% of new M2 creation globally in 2011, as we show in Chart 1. This is not a recent phenomenon - in the-three year period after the global financial crisis began (2009-11), 48% of new M2 globally was in Chinese yuan (CNY; Chart 2). Global M2 is approaching USD 50trn, and China will get us there. Forget about World Bank President Zoellick's successor; Zhou is already the world's banker. There are a few possible explanations for China's massive money creation: The bank-based financial system, where banks are responsible for lending rather than capital markets. However, StanChart says there's not good evidence of correlation between bank-dominated economies and high levels of M2. On a similar theme, the government uses banks to propagate stimulus funds, rather than the government budget directly. It's flat out money-printing to defend the Rmb valuation, however, that is the key cause: Many in Beijing despair about irresponsible money printing by the Fed and ECB. One result of these measures has indeed been the expansion of these two central banks‟ balance sheets (Chart 3). However, the PBoC has a jump on both the Europeans and Americans. Its balance sheet has grown eight-fold since 2002 and ended last year at USD 4.5trn. Balance sheet expansion alone doesn't account for M2 growth, though; much of the bond-buying by the Fed and the ECB leads to excess reserves on banks" balance sheets due to lack of demand for (or willingness to provide) credit. In China, however, the government created massive demand for infrastructure investment as part of its stimulus plan, and the banks lent accordingly. However China's period of "super-fast M2 expansion" may be coming to an end, in part because of slower inflows of foreign currency to China. Foreign direct investment is falling and China's export growth is slowing. The yuan is of course tightly controlled, so the falling M2 growth is also due to deliberate measures - such as moves to reduce banks" required reserve ratios (RRRs), and the slow but steady move towards yuan internationalisation. Importers and exporters, for example, no longer have to exchange their foreign exchange holdings for renminbi. Societe Generale's Wei Yao notes that this change, which has been in effect for some time, has been formally announced by SAFE today. This means Chinese banks and the PBoC, to whom the exporters and importers must sell their forex holdings, don't have to issue so much renminbi in exchange. As StanChart says: This is the fundamental cause of tightness in the banking system today - without the usual inflows of FX funds, base money growth slows, and banks" CNY deposit growth slows. This leads to slower loan growth because many banks have hit their loan-to-deposit ratio (LDR) limits Here's more about the RRR/forex sterilisation mechanism. Another important factor in the impending decline of Zhou's importance in global M2 creation is the Chinese government's falling enthusiasm for foreign currency-denominated debt. As for the FX purchases, StanChart thinks those will head up (in fact, they already are), but the overall rate will continue to slow. For the curious, StanChart says they have defined global M2 as "the combined total of the largest 30 countries‟ M2, used official M2 data, and put aside differences between some countries' definitions of M2'. Related links: China: once again a net buyer of US Treasuries - FT Alphaville China's foreign reserves, not so hot - FT Alphaville This entry was posted by Kate Mackenzie on Tuesday, April 17th, 2012 at 8:19 and is filed under Capital markets. Tagged with PBOC, People's Bank of China, renminbi, Yuan, Zhou Xiaochuan.