Submitted by Pater Tenebrarum – The Acting Man Blog
Chinese Wealth Exodus
Old records are being broken. New records are being notched. On Monday, for example, the People’s Bank of China reported that a record liquidation of foreign exchange reserves occurred in November.
Specifically, China’s foreign exchange reserves declined $87.22 billion in November to $3.438 trillion. This amounts to a monthly sell off of 2.5 percent. What could possibly be prompting the massive sales?
The Great Wall of China – it sure hasn’t been able to keep the money in.
Photo via citypictures.org
For starters, China’s economy is slowing down. Chinese exports, the major growth engine for China’s economy, fell 6.9 percent on an annual basis through October. What’s more, China’s on target to report its slowest growth in the last 25 years.
This means a number of different things. But, at the moment, it means people with money in China are trying to get it offshore and out of Chinese assets. Popular destinations include U.S. real estate and stocks and bonds.
U.S. Treasury data estimates over $500 billion have exited China between January and August of this year. These, no doubt, are massive capital outflows. But, despite increasingly stringent capital controls, forecasters believe the wealth exodus increased in November. Naturally this is stressing and straining the yuan.
China’s foreign exchange reserves over the past three years. The peak in accumulation occurred in June 2014 – since then, more than $500 billion have flown out of China, which among other things is putting severe pressure on China’s domestic money supply growth, as the PBoC’s countermeasures (primarily consisting of lowering required minimum reserves) mainly have “indirect” effects, i.e., they depend in large part on the willingness of China’s commercial banks to extend more credit – click to enlarge.
Manipulation and Intervention
Currency values are determined by market forces of supply and demand. Greater demand for the dollar versus the yuan results in the appreciation of the dollar and, conversely, the depreciation of the yuan. Nonetheless, foreign exchange markets are far from free.
Governments across the globe intervene into foreign exchange markets to manipulate currency values and exchange rates. Sometimes they intentionally try to weaken their currency – exchange it for foreign reserves – to obtain an export trade advantage. At other times they must prop up their currency to prevent a currency crisis.
China’s mass liquidation of foreign exchange reserves is an example of this intervention in action. The mass exodus of capital from China acts as a drag on the yuan. When money leaves China it must be exchanged for dollars or euros or whatever else. Reduced demand for yuan pushes down its value.
The People’s Bank of China likely wants a cheaper yuan. This would make their exports more competitive and stimulate manufacturing. But they also want to limit the potential for the rapid devaluation of the yuan.
In this respect, China’s central bank is attempting to counterbalance the effect of the mass capital outflows. To do this, they are selling some of their hoard of foreign exchange reserves to buy yuan and artificially boost its value.
Given China’s massive stash of foreign exchange reserves, it would take over three years for them to completely sell off these assets at the record rate which occurred in November.
Fighting the Suck in China
Presently, it appears China’s central bank is trying to manage a subtle devaluation of the yuan, which traded at a four month low this week. In fact, on Thursday the People’s Bank of China set the yuan per dollar exchange rate at 0.15 percent discount from its prior fix. Indeed, a graceful, incremental, decline is what they are after.
Obviously, this sort of central bank intervention into currency markets is not without consequences. Moreover, there are limits to what a central bank can and cannot control. Market forces may react to the Chinese central bank’s managed devaluation in ways that throw a monkey wrench into their plans.
In particular, awareness of a small, incremental devaluation can lead to speculation and fear of a much larger devaluation. Subsequent actions of wealthy Chinese to send their capital offshore may, in fact, trigger the larger devaluation they fear. Before you know it, the People’s Bank of China has a grand panic on its hands.
What can Zhou Xiaochuan, Governor of the People’s Bank of China, really do? Should he continue to sell off foreign exchange reserves, prop up the yuan, and attempt to manage a soft currency decline? Should he try to get out ahead of the exodus of capital outflows and force a moderate – say 3 percent – devaluation? Should he cross his fingers and hope things turn around?
In the end, it may not matter what Xiaochuan does to fight it. As China’s economy continues to slow, and exports further dwindle, the deflationary pressure will suck inward until something finally gives. The great Yuan implosion will follow.
PBoC governor Xhou Xiaochuan, here caught watching USD/CNY on his Bloomberg terminal.
Photo credit: AP