Speculative forces, eh?


Lynn Zhang, a Shanghai resident, took three ID cards – hers, her mother’s and her father’s – to a bank branch last summer and bought USD $150,000 to offset a weakening yuan. “It’s not a speculative act but a protective one,” Zhang said. While her expenses in US dollars, mainly on overseas trips, will not exceed USD $10,000, she said a fat dollar savings account was a good guarantee of value if China’s economy continued to slow and the yuan continued to fall.

As yuan depreciation deepens and the fall of China’s reserves accelerates, a growing number of Chinese individuals and companies are rushing to turn yuan into dollars. A wave of money-changing is taking place in many parts of the country, sometimes beyond the capacity of banks to handle, according to the Shanghai Securities News. The State Administration of Foreign Exchange, the foreign exchange regulator, had ordered banks in some areas to limit US dollar purchases this month to curb outflows

Bloomberg, edited for clarity:

China’s $3.3 trillion forex reserves would seem to be a gold-plated insurance policy against the country’s current market chaos, a depreciating currency and torrent of capital leaving the country. Maybe not, say economists. Data point to an alarming burn rate of dollars at the People’s Bank of China. The nation’s stockpile of foreign exchange reserves plunged by $513 billion in 2015 as the nation’s central bank coped with a weakening yuan and an estimated $843 billion in capital that left China last year.

The exact composition of reserves is a state secret. Analysts worry the currency armory may not be as strong as it looks. Some of the investments may not be liquid or easy to sell, or may have suffered losses that haven’t been accounted for. In addition, some Chinese reserves may have already been committed to fund pet government projects like the Silk Road or tens of billions in government-backed loans to countries such as Venezuela. There are other liabilities that China needs to cover, such as the nation’s foreign currency debt to finance and manage imports denominated in overseas currencies. When those factors are taken into account, some $2.8 trillion in reserves may already be spoken for just to cover its liabilities, according to Hao Hong, chief China strategist at Bocom International Holdings Co.

The drop in the nation’s foreign reserves over 2015 was the first since 1992, ending a 22-year ascent that began under former top leader Deng Xiaoping. They fell by $108 billion in December. The falling reserves remains an issue to watch, said Richard Jerram, the chief economist at the Bank of Singapore, who says any fall towards $2 trillion could set alarm bells ringing. “The burn rate has been worrying,” he said. “It’s not about how long it gets to zero, it’s about how long it gets to about 2, which is what they need.”


The monthly fall in December was the first-ever single month fall over US$100 billion for China. “Whether China’s foreign exchange reserves are sufficient depends on what the People’s Bank of China wants to do,” Zhang Ming, a researcher with the Chinese Academy of Social Sciences, wrote in a note. If the central back dispersed speculation of a weaker yuan, the reserves would be enough, Zhang wrote. “But if the central bank continues to intervene against the market by selling US dollars and buying yuan in the quest for a stable short-term exchange rate, and the opening up of the capital account is accelerated,

China’s reserves may not be enough to deal with yuan depreciation and money outflows,” he wrote. Broad money supply, M2, was another benchmark for reserves, Zhang wrote. A country with a fixed exchange rate system needed to have reserves equivalent to up to 20 per cent of its M2. In China’s case, that was up to US$4.26 trillion, Zhang wrote.

“There is a concern that the reserves are falling too sharply,” Zhou Hao, an economist at Commerzbank AG in Singapore, said. “In theory, China shouldn’t worry about this at all; but in reality, reserves are shrinking so sharply that people can’t help asking questions. Remember, China still has a huge trade surplus, but the reserves are shrinking – capital outflows must be quite serious.”


China’s central bank lowered the yuan’s so-called reference rate, its trading peg to the U.S. dollar, by the largest margin since August, when the yuan dropped a couple percentage points over two days. That created a fear that China’s leaders are using a weaker currency to spark growth for an economy that is struggling more than expected. The fact that China’s currency is falling now is a sign that the transition the economy was supposed to be making towards the consumer is in trouble.

Earlier this year, China allowed its currency, the renminbi, to trade within a wider band around the value of the dollar, to which its value is pegged. But instead of rising in value, the renminbi fell against the dollar, and on Thursday the Chinese government allowed (or forced, depending on whom you ask) its currency to go down again, to its lowest value against the dollar in five years.

The biggest fear is a deepening of a trade war that is being fought between the world’s economies over a very limited supply of global demand. One of China’s main competitors in the region, Vietnam, has moved three separate times this year to devalue its currency, with the last coming in August. “The policy action today is positive in its promptness in response to China’s devaluation,” Eugenia Fabon Victorino and Irene Cheung, analysts at Australia & New Zealand Banking Group Ltd., said in a research note at the time.

Meanwhile, other big exporters like Japan and Korea, have been watching the moves in the renminbi closely. Korea’s won hit a three year low earlier this year, while the Japanese central bank has been engaged in massive monetary stimulus in recent years. The Japanese government argues that this is purely to stimulate domestic demand, but economists like Robert Scott of the Economic Policy Institute have argued that Japan’s tactics are different than, for instance, the Federal Reserve’s quantitative easing, and that currency manipulation on the part of Japan has cost the U.S. hundreds of thousands of jobs per year.

As economist and China expert Michael Pettis has argued, what China’s troubles today underscore is the dearth of demand in the global economy. There are virtually no economies on earth today that are growing quickly as the result of rising incomes. Instead China’s rapid growth, until recently, has mostly been the product of a government policy that encourages excessive investment and keeps wages low in order to boost exports and employment.


China claims it has a ‘stable and healthy’ financial system. The renminbi fell 1.5 per cent against the dollar in onshore trading last week to Rmb6.59 — a sharp move for the carefully managed currency. Traders have largely ignored the central bank’s guidance that they should focus on the renminbi’s stability against a basket of 13 currencies rather than volatility against the dollar.

Offshore the renminbi fell 1.7 per cent against the dollar to Rmb6.68, widening the spread between the two rates to a record level. The gap implies that international investors are pricing in further weakening of the onshore rate. Before the People’s Bank of China unexpectedly devalued the currency in August, the two rates traded at virtually the same level.

More recently, the PBoC has been letting the onshore rate weaken and intervening in the offshore market to limit the gap. Separately, the State Administration of Foreign Exchange (Safe) has been scrutinising banks that help clients arbitrage between the two – a move that some critics feel is inconsistent with the International Monetary Fund’s recent designation of the renminbi as an official reserve currency under its special drawing rights (SDR) regime.

“We seem to be drifting back into a two-tiered renminbi system and that is worrying,” said one investment strategist, who asked not to be named. “How can you be in the SDR and yet you penalise banks for arbitraging between the two rates?” he added. “It’s outrageous and wrong. They shouldn’t be in the SDR and doing that. They should be making sure they continue liberalising to unify the two rates.”

The IMF identified the rising spread between the onshore and offshore RMB rates as an “operational challenge” when it decided in November to include the currency in the basket used to value its special drawing rights from October 1 this year. But it also argued that reforms underway would eventually allow “unencumbered” access to China’s onshore markets. Any moves to restrict that access so soon after its big vote of confidence in Beijing and China’s reform path would be potentially embarrassing for the IMF.

In a statement at the weekend, Safe tried to reassure investors. “China’s economic fundamentals are strong,” the regulator said. “Foreign exchange reserves are relatively abundant and the financial system is largely stable and healthy.” The PBoC last week blamed “speculative forces” for the renminbi’s recent weakness.

Based on all of the above, we expect to see continued yuan weakness and increased capital outflows. How the government handles this will be interesting to see. NB: when they begin to blame “speculative forces,” watch out!

One Response to “Speculative forces, eh?”

  1. feeblemind Says:

    So . . .

    China’s problems in no particular order include:

    1) Way too much debt.

    2) Declining world demand for their exports.

    3) A serious level of capital flight.

    4) A price cutting war with rival exporters via currency devaluation.

    5) Labor unrest.

    6) Massive industrial overcapacity.

    7) A crashing stock market.

    Those represent a lot of holes in the dam. Can they patch the holes or will the dam burst?

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