2012-07-10

China's dollar short position

Earlier this week in Chinese hoard dollars, we saw that Chinese exporters are holding onto their U.S. dollars and repaying U.S. dollar loans.

FT Alphaville took an in-depth look at the numbers in China and those dollar shorts, and draws a similar conclusion to mine:
BoAML’s last attempt to downplay the importance of these shorts is to claim that none of this matters in the grander scheme of things because the shorts are ultimately a sovereign liability rather than a corporate one due to the state’s long-standing intervention in the FX market. And, as everyone knows, China on a sovereign level is definitely not dollar short.

But this again is missing the point. Which is that China’s short-term dollar liabilities are currently balanced by longer-term dollar assets. They represent a duration mismatch. That China can liquidate its holdings is obvious. It’s about how you interpret these liquidations if and when they happen.

That is to say, one should not regard them as dollar negative but rather as dollar positive.

One last unintended side-effect is the pressure the dollar shortage is putting on RMB liquidity in its own right. Dollar absorption, after all, has always provided a key RMB liquidity distribution mechanism for the PBoC. Hence the growing need for alternative PBoC liquidity measures such as reverse repos.

FT Alphaville had report on China's dollar short position (coming from the corporate sector) in late June: China’s remarkable short USD position. That post discussed Standard Charter's estimate of an $800 billion short position.

If China is short dollars, it means the banking system has excess renminbi. A closing of this position is deflationary, but the central bank started cutting interest rates and reserve requirements. Instead of draining yuan as dollars are pulled from the system, they are instead inflating the money supply, with the long-run consequence of devaluing the yuan. Whether the yuan is currently under, over or fairly valued will determine which direction it trades in, but the net effect is to weaken the yuan.

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