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China looks good

China's central bank today announced it was raising its required reserve ratio from 15.5% to 16.0%. Is this a reason to fear that the Chinese boom may turn into a bust? Hardly.

China's monetary policy is largely determined by the Federal Reserve, because China pegs its currency to the U.S. dollar. However, the Chinese have been reluctant to be completely at the mercy of Bernanke and Greenspan's whims. As the next chart shows, they allowed the yuan to appreciate against the dollar from 2005 through 2008, largely in response to the fact that the dollar became seriously weak over that same period. Why stay pegged to a collapsing currency? Better to float the yuan higher.

Allowing the yuan to appreciate was equivalent to a tightening monetary policy that in effect helped counteract the extremely easy monetary policy coming from the Fed during that period. To complement this tightening the Chinese central bank also raised its required reserve ratio from 6.0% in 2003 to 17.5% in mid-2008. The Chinese, like the Australians, are proactively tightening monetary policy, and the Fed should be following their example. This is not bad news for China, it is good news. Sound monetary policy is an essential ingredient to strong growth. And to judge from the top chart, China is back on track to more double-digit growth.

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