An Unexpected Improvement…
The Wall Street Journal has just run an article about the latest data manipulation coming out of China. China is experiencing strong currency outflows. This is a combination of “hot money” from outside China, which came into the country to bet on an appreciating currency (the yuan) and is now retreating, and domestic money that is looking for a foreign home now that the Chinese bubble is appearing less and less sustainable.
In a reversal of the process that I described here, this is causing China to spend huge amounts of its foreign exchange holdings to prop up the yuan. This is the exact opposite of what China had been doing, which was to accumulate foreign exchange reserves as it depressed the yuan. China is holding up the value of the yuan now because, although it ultimately wants to see the currency fall, it is worried that a sharp decrease will cause a self-fulfilling and destabilizing flight.
Investors have therefore been watching the monthly reports of China’s foreign exchange holdings with interest to gauge the amount of capital flight and the ability of the Chinese government to support the currency. The numbers have not been comforting: foreign exchange holdings dropped from a peak of almost $4 trillion in March 2014 to $3.2 trillion in February 2016.
During most of 2015, the fall was running at about $80 to $100 billion per month, even though China was running a large balance of payments surplus, which would normally increase the amount of reserves. Traders were beginning to speculate on how much longer China could continue to bleed.
And then it stopped: in February 2016, the monthly drop equaled $29 billion, down from $99 billion in January. Investors breathed a sigh of relief. It looked like the yuan wasn’t going to detonate, which was one of the possible “black swans” behind the fall in global markets at the end of 2015 and the beginning of 2016.
Lies, Damned Lies and Statistics
But, of course, they lied. Instead of buying the yuan in the “spot” markets, paying for the purchases with foreign exchange reserves in a way which is highly visible, the Chinese government has been using its lapdog banks to purchase the currency in the “forward” markets. These forward purchases hold up the current value of the yuan since the forward and spot markets are mathematically linked through interest rates.
The benefit for the Chinese is that forward purchases, which may not settle for months or even years, do not show up as an outflow of foreign exchange reserves for a long time. This allows the Chinese government to pretend that the pressures on its currency are waning and that it is winning the battle against those nasty speculators.
Since, as I have noted before, the drawdown of foreign exchange reserves also tightens the domestic money supply, it also helps China to continue to run the very loose monetary policy that the government thinks is necessary to hold off recessionary pressures.
The WSJ article speculates that China may have $150 to $300 billion in currency forwards, most of which have been built up over the last few months. The article also points out that the IMF, which has just promoted the yuan to the currency major leagues by including it in its Special Drawing Rights, is pressing China to disclose information on its forward positions.
The Chinese authorities promised to provide more information on its currency maneuvers when it joined the SDR in December of last year. But apparently they have already forgotten. If it is true that China has rapidly built up this large forward position, it would mean that pressure on the yuan is continuing at a high level. It would also mean that China is maintaining its world-leading position in falsifying economic statistics.
Charts by: TradingEconomics, BigCharts
Chart and image captions by PT
This article was originally posted at Economic Man.
Roger Barris is an American who has lived in Europe for over 20 years, now based in the UK. Although basically retired now, he previously had senior positions at Goldman Sachs, Deutsche Bank, Merrill Lynch and his own firm, initially in structured finance and latterly in principal and fiduciary investing, focussing on real estate. He has a BA in Economics from Bowdoin College (summa cum laude) and an MBA in Finance from the University of Michigan (highest honors).
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