The Fix of China’s Fix

Submitted by Jeffrey Snider  –  Alhambra Investment Partners

It wouldn’t be “reform” if it wasn’t seemingly contradictory and confusing. It is increasingly apparent that investors and observers look at everything in binary terms; something either isn’t or it is. In China, the entire premise of what they are doing takes more than one form, as it can look to be conflicting in the sense that the PBOC both “tightens” and “loosens” at the same time. That is the nature of trying to wean off monetarism’s asset bubble byproducts of great inefficiency.

Yesterday, the PBOC raised its yuan reference “fix” to 6.1318, a significant difference to offshore trading rates that have seen the currency depreciate as much as the first wave of “reform” in early 2014. It was an effort aimed at liquidity financing speculation, assuming that the net effect is to cause “outflows.”

ABOOK Feb 2015 China Yuan

I wondered earlier in the week if the PBOC had finally met its limitation, and the answer appears to be a qualified more of the same. In what is like a liquidity twist, the “tightening” aspect of raising the official currency reference is then undone, somewhat, as there is no precision here, by the nearly simultaneous reaction of reducing the RRR by 50 bps. However, the PBOC made further liquidity steps aimed at particular institutions, like the Ag Bank, those already deemed “good” and “necessary” by the PSL conduits last year.

The fact that Chinese “markets” were caught by surprise I believe adds to the list of evidence in favor of nothing but “reform”, not economic concerns, driving activity. Swap prices in China rose yesterday by 16 bps, a significant increase, meaning that money “markets” were taking the yuan reference as exclusively “tightening.”

In other words, they are still trying to remove “excesses” while at the same time making sure that any offsetting pressure is handled – especially targeting the parts of the financial system that are part of the new core of more responsible financial industry.

“Looking at the reverse-repo rates, the central bank isn’t trying to send a loosening signal as the currency is under depreciation pressure,” said Sun Binbin, a Shanghai-based analyst at China Merchants Securities Co. “The greater the depreciation pressure on the yuan, the less attractive the currency will be on the international market. This conflicts with the authorities’ ambitions to internationalize the currency.”

I think that is about right, as the entire point of “reform” is stabilization in finance and then the economy. The trick is whether both can happen at the same time, or near enough, but risking the very serious downside (for both “markets” and the economy) if they get too far out of sync.

Part of the problem, specifically as it relates to the financials, is that China has been increasingly dependent on “dollar” funding. We have been led to believe that the Chinese “dollar” short is entirely encompassed within the corporate sector as a matter of imbalanced trade, but increasingly, as these central bank activities suggest, there are indications of the “dollar” short acting as it has almost everywhere else. Some call this “hot money”, but it is the Asian version of the eurodollar bastardization of global finance.

It has only gotten worse despite continued PBOC attention (again, central banks, even in China, are not as all-powerful as they present themselves to be).

China’s capital account posted the widest deficit since at least 1998 in the fourth quarter as companies increased overseas investment. The capital account shortfall was $91.2 billion in the three months through December, the Beijing-based State Administration of Foreign Exchange said on its website Tuesday. The current-account surplus shrank to $61.1 billion.

As mentioned above, I’m pretty sure that “overseas investment” is not the correct characterization. A wider capital account deficit, assuming it can capture a sufficient proportion of activity versus what takes place unofficially, can easily be the “dollar” problem growing into a larger problem. That makes this a funding issue, and thus a liquidity issue.

So the seemingly contrary actions of the PBOC are not at all; simply the same effort to handle liquidity chaos by attempting its refocus and ultimately its re-engineering. As I have said throughout, this will be a remarkable feat if they pull it off. Given the already sordid economic state, I think it may end up as being too lofty a goal, which only reinforces the severity of the problem – to make such an attempt right now can only mean that the alternative of doing more of the same (“stimlulus”, more inefficiency, bigger asset bubbles) is worse.