It’s a problem that has been talked about before — inside China it’s what the yuan does against the dollar that seems to matter. Which is awkward because China is quite keen on people concentrating on what it does versus a basket of currencies.
The potential consequence of that USD fixation is that if the $/CNY rate goes higher then there is a risk that capital flight picks back up again in tandem with expectations of further depreciation, no matter what the RMB is doing against that currency basket.
In the words of Goldman’s Robin Brooks and team:
China is pursuing a shift in its currency management, towards a trade-weighted exchange rate and away from the bilateral exchange rate versus the Dollar. That shift makes sense conceptually, given that monetary policy normalization in the US is likely to push the Dollar up, so that some weakening of the RMB versus the greenback can certainly be justified given China’s cyclical position. But the shift to a trade-weighted exchange rate has a weak link, which is that the main signal for households and businesses within China remains the bilateral exchange rate versus the Dollar.
In short, for a given amount of capital controls, China is doing just fine on the reserve front:
For years the Chinese government accumulated claims on the rest of the world, with foreign reserves soaring almost continuously to a peak level of just under $4 trillion in 2014. Then things went into reverse:
Which is sad, but at least he’s talking and talking at length.
Before we get to that though, it’s worth having a read of George Magnus and Eric Burroughs on Chinese capital outflows, reserves and the country’s ongoing FX trilemma — China cannot “pursue more than two of an independent monetary policy, a fixed exchange rate, and free capital movements simultaneously”. They’re good catch ups on where China is now and the prospects of a float, devaluation or increasing capital controls.
It’s also broadly what PBoC governor Zhou discussed, among other things, in a lengthy interview to Caixin over the last few days — after a long period silence — and a transcript of that interview is now pixelated and ready for your eyeballs.
We thought we’d aid that eyeballing and pick out some sections of the interview and put a summary of sorts near the bottom. It’s best to skip down to there if you’ve already read the full thing. The extracts are chunky, as was the interview — which you could maybe read as some 10,000 words of PBoC versus the speculators. Read more
Which leads us, naturally, to a partial Fed transcript from August 1985: Read more
You’ll remember that persistent capital outflows from a slowing, debt burdened China are a thing.
You’ll also remember that FX reserve depletion is a thing as China attempts to control the pace of RMB depreciation. Or, at least, probably does. Christopher Balding suggests we call what’s happening to the RMB a “devreciation” or “depaluation” — a devaluation-depreciation mash-up for those slow on the neologism take-up.
And you’ll probably remember that we got our China FX reserve data for December last week. Read more
In which October’s brief respite gets absorbed into a pretty clear trend.
First things first, and to repeat ourselves, China’s recent devaluation was pathetic.
We mean, really, what is this?
Then being the ‘taper tantrum’ in 2013.
Now being the recent China devaluation episode that caught so much of EM FX in its backdraft.
From Goldman’s chief FX strategist Robin Brooks, and with our emphasis: Read more
Not so bad this month, particularly when you take into account expectations and the headline $94bn fall we saw in August.
Chinese GDP or employment data, meh.
These days the only data that really matters are Chinese FX reserve statistics. The latest month’s position is due to be released overnight, and Daniel Tenengauzer of RBC Capital Markets expects we could be in for another episode of declining coffers:
We believe China will continue to post outflows for two reasons. First, interest rate differentials against the US declined by 200-250bp since January 2014. Even assuming no imminent lift-off in the Unites States any time soon, the flows will likely pull USD/CNY higher. We believe there is about USD400-500bn of pipeline demand in short-term international claims just to reverse some of the flows observed since 2010.
We estimate that in August there were about USD100bn of outflows. As global FX reserves accumulation turns around, the same things FX reserve managers aimed to buy in the past ten years or so will also turn around as well; this includes a variety of short duration fixed income products and alternative currencies to diversify trade weighted index baskets.
When your correspondent visited pawnshops in Macau this week and asked whether they could help him shift 1m yuan ($157,000) out of China—three times what one can legally withdraw in a year—most demurred.
- Anon (ish), Economist, Sept 19
Sad really to see them in such decline, even if said correspondent did find a brave few who would help.
Nervous times is the headline reason for their nervousness, what with all those police raids and a general chill redescending along China’s capital-borders as flows out of the country continue to make the government nervous — even if some of the headline outflow (a record of over $150bn or so in August according to estimates) is probably just dollars being hoarded by Chinese corporates, it’s very clearly a point of stress for China’s leaders.
Which is fair when you consider what it would mean for Chinese reserves if it chooses to absorb the capital outflows and what it means for the CNY if it doesn’t. Read more
And here’s that paragraph, from JPM’s Niko Panigirtzoglou and team, with our emphasis:
- First, we disagree with the description that FX reserve depletion is QE in reverse. This is because the FX reserve depletion that is happening currently is not an exogenous policy action but represents a policy reaction to capital flows out of EM. But the capital that leaves EM does not disappear from the financial system. In fact, the capital that flows out of EM could find its way back into DM bonds. For example three major manifestations of capital flowing out of EM are 1) the reduction of dollar denominated debt previously issued by EM corporates, 2) the accumulation of dollar deposits by domestic EM corporates or other entities who try to protect themselves against further dollar appreciation, and 3) the withdrawal of EM currency (e.g. Renminbi deposits) by foreign investors who in turn convert them back into dollar deposits.
From Barc on what’s happened since the PBoC got messy at band camp, devalued, and followed up with a “dirty peg”:
From UBS’s Tao Wang on what, post China’s surprise revaluation, is now an oft used phrase, the impossible trinity — AKA the corner China finds itself in:
The impossible trinity says that a country cannot simultaneously have an open capital account, independent monetary policy, and stable tightly managed exchange rate. Some academics (such as Hélène Rey) argue that since capital controls are no longer as effective in the current day world, complete monetary policy independence is still not possible without some degree of exchange rate flexibility, even without a fully open capital account – or impossibly duality.
Regardless of whether it is an impossible trinity or duality, the fact is that in recent years, as a result of substantial capital controls relaxation, China has found it increasingly difficult to manage independent monetary policy while simultaneously maintaining a fixed exchange rate.
Things that are not infinite include… China’s FX reserves. Even at $3.7trn.
It’s an obvious point, but maybe the point is worth remaking.
From Soc Gen’s Wei Yao: Read more
By Christopher Balding, Professor of Economics at Peking University, HSBC Business School, and blogger at Balding’s World.
The job of the modern economic and financial policy maker is a difficult one. Markets are being created at breakneck pace to trade incredible varieties of financial products and the complexity of major modern economies is dizzying. Considering the constraints of managing enormous economies and financial products, the most important asset of the economic regulator is not perfect decision making but credibility.
As China has battled a variety of financial pressures this year — from a falling stock market to capital outflows pressuring its US dollar peg — Beijing’s lack of a credible coordinated policy response worsened their public reception. Rather than articulate a clear vision of how to address a falling stock market and slowing economy and proceed to methodically execute that plan, Beijing swerves between conflicting announcements and less than credible positions that the market discounts. Read more
Sensible sentences from Citi’s Buiter et al on China’s valuation shock (with our emphasis):
This decision by the PBOC is a significant event, even if its implications and motivations are not yet fully clear. It appears that the Chinese government has moved from operating a pretty stable peg to something closer to a managed float, raising questions about how strongly it will manage it. As liberalization proceeds, (sterilized) foreign exchange market intervention will effectively only work through signaling and announcement effects. However, ‘domestic’ interest rate policies, credit and other financial and/or fiscal policies are likely to gain strength as well as they affect the ‘market-determined’ exchange rates. As such, monetary policy and exchange rates will work in tandem as there is no such thing as a policy independent exchange rate, regardless of how freely it floats…
This is something we’ve banged on about before — that there is always a cost to exchange rate movements and in China, where stability of the system is so highly prized, those costs can get unacceptably high very quickly. We argued that case where capital outflows were concerned and now Deutsche’s Alan Ruskin is doing the same with the recent stock market turmoil in mind.
First though, he compares this stock puke to the US experience in 1987 (with our emphasis): Read more
Some more sentences about China, this time from BNP Paribas’ Richard Iley:
It has been a near unshakeable axiom that China’s economy is on a pre-determined flight path to overtake the US and quite quickly become the world’s biggest economy. But China’s rapid nominal compression combined with the end of RMB appreciation vs. the USD and the solid c.4% nominal GDP growth in the US economy mean that, for the first time in a decade, China’s catch up with the US has stalled. Q1 GDP data is not yet available for the US economy but, assuming a cautious 2.5% annualised increase, helpful base effects would still leave nominal GDP at c.4.5% y/y. The US has therefore almost certainly grown faster than China’s in USD terms over the last year for the first time in well over a decade (Chart 5 & 6).
Another BoAML FX observation on Thursday, this by way of Claudio Piron, emerging Asia FI/FX strategist, and his team.
On the analysts’ radar this week, the continuing risk of CNY depreciation, and in particular this chart:
Clearly there are incentives for China to join the currency wars in earnest.
The RMB is up 6 per cent in Nominal Effective Exchange Rate terms since August 2014 with, say SocGen, the JPY, EUR, KRW and RUB the top contributors, accounting for 1.9pt, 1.3pt, 0.5pt and 0.4pt of the appreciation respectively. Honourable mention to the USD, naturally, against which the RMB is up 0.5 per cent.
Nine days in and it’s still falling…
Some analysts had thought Beijing was ready to let the renminbi stabilise, but a sharp sell-off on Friday – at one point it declined 0.9 per cent, its biggest daily fall since the new currency system was introduced in 2005 – showed that the central bank was still determined to push it further.
“We’re still seeing PBoC intervention”, said a trader with a bank in Beijing. “This is beyond our expectations.”
Argue about more sweeping policy changes as you will (the bet is still basically on a PBoC attempt to deter speculative inflows) but maybe keep an eye on the 6.20 level as you do. Read more
It’s not an easy concept for some gold lovers to grasp, but… a nation importing huge amounts of gold into its economy doesn’t necessarily reflect prosperity on its part. In fact, it can imply economic weakness around the corner.
Prosperous countries, after all, don’t need gold (or huge amounts of foreign reserves for that matter either) to back their fiat currency. They don’t need them because they are so mighty, productive, knowledgable, powerful and desirable to live in that they have seigniorage power all of their own accord. You know. Like Bitcoin. But not because they are artificially scarce, but because they are managed well.
Also, even if you go with the goldbug logic that fiat ‘money printing’ equals debasement, it must then also imply that mass gold importation equals the opposite: purposeful rebasement. Someone is trying to bolster what would otherwise be a naturally weak currency. Read more
The assumption for a long time has been that when a free floating yuan is finally born step 1 on its journey would be a joyous rush of capital inflows sweeping it upwards as foreigner investors finally got to jump into China with both feet.
But, as we’ve been arguing for a while, that might not be true anymore. Diana Choyleva of Lombard Street seems to agree: Read more
China’s State Council has announced intentions to carry out some potentially quite big reforms. From Bloomberg:
China signaled it will propose plans this year to allow freer flows of its currency in and out of the nation as part of measures to loosen control over the yuan and interest rates. Read more
China’s balance of payments deficit in the second quarter was its first such deficit since 1998, and it attracted a lot of attention. Together with other bits of data about currency flows, it heightened fears about whether there was some kind of capital flight out of the country, and what it would mean for domestic monetary policy just as the economy became slightly stretched — but still somewhat inflationary.
But it’s not so bad, Societe Generale’s Wei Yao says. Yao looked through the details of the State Administration of Foreign Exchange data from Q2 and reckons most of it can be explained by fairly normal changes associated with the authorities’ tentative steps towards renminbi internationalisation: namely, an increase in private foreign currency deposits (as opposed to the official reserves), and credits to foreigners on domestic banks’ balance sheets. Read more
The reversal of currency flows in and out of China is continuing. The PBoC published data on Tuesday showing that the country’s banks were net sellers of yuan in July, selling Rmb3.8bn or $587m. As the WSJ’s Tom Orlik explains, this means that the banks’ foreign exchange purchases are lower than the monthly inflows from trade and investment, and it suggests some “hot money” is leaving — possibly in part because exporters and importers no longer want to settle in yuan.
Of course this is only a change in the direction of flows — and a small one when viewed in context. The chart below from Chinascope Financial demonstrates how, while the trend has been negative since September 2010 and particularly since September 2011, the banks’ overall forex position hasn’t changed that much in the past year: Read more
Meanwhile, in the domestic banking scene… [See part 1 on capital outflows here.]
China’s financial system stability is increasingly intertwined with its shadow banking system — which is big, according to various tallies. Bank of America Merrill Lynch says it accounts for a quarter of all bank loans, with the biggest segments being wealth management products or WMPs (8 per cent) and trust companies (8.9 per cent). Fitch Ratings says that WMPs now account for about 16 per cent of all commercial bank deposits; KPMG says trust companies will overtake insurance to become the second-biggest component of the financial sector. Read more