Can anyone explain this to me? My interpretation is the central bank exchanges exporter’s foreign currency for RMB. How does it become bank loans?
Customer wires USD 1,000 to bank B to the account of business A as payment for the goods.
This money does not go directly to the account of business A.
Bank B sends USD 1,000 to Central bank and gets RMB 7,000 (or whatever the exchange rate is) which go to the account of business A.
Bank B ends up with deposits almost entirely in RMB to loan out. Few customers outside China really want those.
Compare with a situation in which bank B kept its USD on the books as customer deposits. Then it would have USD to loan out, and the market for such loans is much bigger.
Hence probably why China is pushing other countries to use Yuan as an exchange currency?
Because the banking system is tightly controlled by the party-state – with state-owned or state-connected enterprises serving as the fiefdoms and cash cows of elite families – the state sector enjoyed privileged access to state bank loans, which were used to fuel an investment spree. The result was rising employment, a temporary and localized economic boom, and a windfall for the elite. But this dynamic also left behind redundant and unprofitable construction projects: empty apartments, underused airports, excessive coal plants and steel mills. That, in turn, resulted in falling profits, slowing growth and worsening indebtedness across the main sectors of the economy.
Which looks eerily similar to the influx of outside capital in cities like mine, which are experiencing unprecedented growth as huge apartment complexes are built for millions of dollars, while the average person can't afford a $500,000 home that was just $150,000 a decade ago. Because access to capital has been ..corrupted? I don't know the right word.
So we have all of these people working as hard as they can to build nonproductive infrastructure. A healthier investment might look like NOT paving farms. Or expanding mass transit. Or funding education. Or stimulating the commercial and industrial sectors. Or doing anything else at all really.
We already went down this road in the 2000s, when the Dot Bomb strategically crashed the economy to give Bush the win in the Bush v. Gore decision, so that attention could be distracted away from sustainability investments like electric cars and solar, towards militarism and a buildout of the housing market which led to the housing bubble popping in 2008. IMHO the US never recovered from that, so now it's all these shell games designed to keep capital out of the hands of everyday working people, who will be left behind as we transition to a rent-based economy of global neofeudalism.
Beneficiaries are not the ones paying in with their time and effort, which creates low morale in the economy and causes the 20% unemployment in youth who have rightfully spotted that the economy is rigged. I think this will become more prevalent as authoritarianism rises and AI eventually takes an oversight role while having no accountability.
BTW this is all fixed through tax policy. We simply tax the wealthy at post-WWII levels until the national debt is paid and workers return to a livable wage as the middle class grows. Note that that's the only thing we haven't tried, which is why no progress is being made.
When an exporter in China gets foreign currency for their export, it goes to the exporters bank. The exporters bank "sells" the foreign currency to the central bank. In this sale, the central bank usually "prints" the yuan to exchange for the foreign currency.
When a trader in China imports goods, it asks their bank for foreign currency. They give the bank yuan. The bank sells the yuan for the foreign currency with the central bank. The central bank sells it's foreign currency assets and "extinguishers" the yuan they received.
It's not as simple as this but this is the theory.
Since they’re the entity that makes the RMB, and a lot of people want to buy stuff from them in dollars, they collect a lot of dollars and print a lot of RMB.
The flip side of that is because they don’t have a big consumer economy, not as many people want to buy things in USD by converting their RMB (especially since the exchange rate is fixed at an unfavorable level).
So net net they have more dollars becoming RMB than vice versa. Those RMB become worth less anytime anyone exchanges them into another currency (because the fixed exchange rate), so they need to spend them in ways that don’t require an exchange.
Then domestic investors way over-invest in domestic projects, which leads to inefficient cities in the countryside.
Do you mean in China or generally?
I’m not a finance person but my understanding is that fractional reserve banking is fairly common.
There is a concept of reserve in the system. That is: banks must keep a reserve with the central bank relative to the amount of new money they are creating through loans. At the moment though, that reserve ratio is 0 (zero) for the UK and the US, rendering it meaningless.
Say the banks are creating new money through these loans. And then enough of the original depositors plus some of the people that have been lent money want their money out that the bank can’t give it to all of them. From a layperson’s perspective (like mine) this seems like the bank has loaned out their deposits — it seems like a distinction without a difference to me.
What am I missing?
When you deposit money into a bank a few things happen:
- The money is no longer yours, it's the banks, you have no ownership of it anymore
- The bank creates an IOU (a deposit) in your account to say that you may request money equalling this value at any time. You can spend this IOU in various places, it is widely accepted as money. This "bank money" is confusingly referred to as dollars (or whatever your currency is), just like actual cash is.
- Completely separated from handling deposits, another arm of the bank creates loans, which also creates IOU's (deposits) in their respective account.
- Someone given a loan may request to withdraw cash (or a transfer), which may force the bank to reach into it's reserves, which is partly made up of customer cash deposits. These reserves are owned by the bank, not depositors. Banks are not holding onto depositors money in a strict sense, it's the banks money until an IOU is called in.
I think the last bit might be where the question about the "distinction without a difference" might be coming from? when the borrower requests cash, they are not "withdrawing" their loan, they are cashing in their deposit of "bank money". Because the percentage of reserves is always vastly smaller than all deposits they hold, bank runs are always destructive on the system. The whole system is a massive plate spinning act that works fine if the plates keep spinning.
I think this is one of those "technically true" things, but it works out very similarly.
You deposit $1 with the bank. The bank now has a liability to you of $1, and deposits the $1 with the bank's bank (often the central bank).
hand waving
Separately, the bank is able to negotiate for loans from the central bank. This is on the basis of its demonstrated capital controls, liabilities, deposits (with the central bank, including your $1), business plan, etc.
When the bank receives a loan from the central bank, there isn't necessarily any cash moving around. It's literally just numbers in a ledger, and a system of governance where eventually guys with guns will liquidate the bank's property if they don't handle things properly.
The central bank wants a cut of the action in terms of the prime rate. Whether the local bank can lend directly from deposits depends on how much control the central bank wants to exert, since this is an end-run around the monetary policy and oversight.
This is not how it works. You deposit $1 with the bank and create a liability. The same day, another branch makes a loan and creates new deposits from thin air. At the end of the day, the bank figures out its reserve position. If it is short, it borrows reserves from other banks.
Loans precede deposits. Always.
Banks are subject to capital requirements, and are concerned about profitability and loan losses, so they don't make an unlimited number of loans.
This might seem like semantics but someone who believes reserve requirements and deposits are the limits on lending would find it tough to explain why banks aren't lending huge amounts after the reserve requirement in the US was cut to zero.
Arguably the most important constraint on a bank's ability to create new loans (and hence new deposits) is its core tier one capital ratio: that is, its total liabilities divided by its shareholders' equity.
The tie to RMB is critical for the Chinese economy because of its dependence on foreign investment