Beyond just the daily band, to peg CNY around the midpoint and to keep that midpoint nearly the same every day requires constant vigilance and direct activity. You might amass a war chest of off-balance sheet funds using “contingent liabilities” staggered out at three-month intervals.
In other words, you borrow
a ton of US$’s
upfront in FX swaps and the like, keeping them off the books (kind of). The first batch of those swaps will be coming due three months from now. The second in six months. And so on.
You use these “contingent liabilities” you’ve gathered ahead of time as fuel, doling it out in piecemeal fashion to fight the daily war to keep CNY close to its midpoint. If you can keep it near the midpoint that also means you can keep the midpoint from moving much day to day. The steadier the exchange value, maybe to the point of it looking like it is pegged, the costlier the output.
If you are being bold, like the PBOC, say, in November 2018, you could even try to engineer a higher CNY – but that’s going to mean using up a lot of ammunition.
The goal is relatively simple: convince the market that nothing is wrong, or at least if there is something wrong it’s not something you can’t handle (and the media will help you out by claiming all these things). The currency appears to be stable, and that will let time heal every wound. Three months from now when the first batches of FX swaps begin expiring, you hope and expect that whatever was bugging the eurodollar markets no longer is.
If on the other hand the eurodollar system is unconvinced by an artificially stable CNY, you’ve just made it worse (
the nightmare).
To oversimplify again, let’s assume [local banks] need to borrow $100 every day in short-term eurodollar markets just to keep doing the vital economic and financial things [banks] do. One day, the eurodollar market demands $110 for whatever reasons including problems on its own end. As the central bank, [you] promise to help [them] by giving [them] the extra $10 because [them] not having that $10 means [they] don’t get all of the $100 and therefore all sorts of bad things for you as well as the economy.
[You] can sell $10 in assets [you] already own, which, as noted above, means that’s $10 subtracted from the domestic monetary base. Or, the Brazil option, [you] can give [banks] $10 today by promising to obtain $11 three months in the future. It sounds absurd, but that’s really what happens and it keeps the $10 in place for the domestic base while simultaneously giving [banks] an acceptable liability covering [their] $10 shortfall.
Three months later, [they] are still borrowing the $100 on eurodollar markets as [they] always do, but now [you] have to borrow $11 on top of it, to close out that prior intervention. If the eurodollar market has gone back to normal, great. If the eurodollar market still demands $110 from [them], then [you] have double the problem.
