2012-08-24

PBOC can't buy a buck; talk of depleted reserves is not alarmist

China's central bank sees dwindling U.S. dollar purchases as foreign investors stay home, domestic investors go abroad, and exporters hoard their greenbacks. This is slowing the rate of money supply growth, since the PBOC pegs the currency to a basket of foreign currencies.

Mainland slows down forex buying
Foreign exchange accumulation on the mainland decelerated drastically this year, limiting the central bank's alternatives in boosting money supply.

The People's Bank of China's purchases of foreign exchange totalled 298.8 billion yuan (HK$365.79 billion) in the first seven months of the year, a year-on-year slump of 87 per cent, it said.
The currency is a long-way from a crisis, but if the central bank fights deflation now, it will certainly weaken the renminbi in real terms. But while there's continued talk of easing and stimulus in the press, there's still no sign of it.

Here is a Chinese commentary on it, echoing Western opinion, and essentially saying "nothing to see here, move along." 如何看待外币存款较快增长

Were the currency flows reversing during a growth phase for the global economy, this attitude would be correct, but these flows are reversing as the global economy enters a sharp slowdown. The global economy is headed into another recession, and that raises the risk that China's currency inflows, already down 87%, fall more than 100%, i.e. China starts exporting foreign currency. China will experience a major bout of deflation and their policy response at that point could trigger depreciation in the renminbi and exchange rate driven inflation.

Also Sprach Analyst has a post The policy tool PBOC has when China’s economy gets really bad
A large-scale asset purchase programme (a.k.a. quantitative easing) is not without problem for China, and there are many reasons not to expect that to happen any time soon. Despite deleveraging and overcapacity, potential inflation and the resilience of the real estate market remains a concern for many Chinese, including the leaders. Indeed, as the experience in the US shows, despite lack of threat of (hyper)inflation, many people continue to believe that such risk exists. Not to mention that the Chinese central bank has been a champion of “printing money”, and everyone knows and loathes it. As the expectation of Chinese Yuan depreciation is building up, QE-ish operation will only increase that further. In today’s environment, the PBOC can’t possibly do this.

However, given the on-going trend of very weak economic activities and the liquidity tightening arises from outflow and possibly rising bad loans, we suspect there will come a point when even cutting RRR aggressively will not be enough to maintain liquidity condition, and that will necessitate some asset purchases programme in one form or another. The timing of the possible asset purchases in unclear, but we think the probability of such occurrence is increasing, and the market, particularly the bulls, have not been paying enough attention to the existence of such a tool.
It will come in the depths of deflation, as predicted previously by Liu Junluo, see Liu Jun Luo: Six to ten months until Chinese hyperinflation. He wanted the government to create wage inflation (whether it was possible is another question), but things are proceeding as he expected: deflation, to be followed by a currency crisis.

Here's an opinion that one doesn't see much in any press: Chinese are actively discussing the possibility of their forex reserves being depleted. 外汇会耗尽不是危言耸听 (Depleted reserves is not alarmist talk)

This piece is by Tan Yaling, head of the China Research Institute of Foreign Exchange.

She says there was a recent article stating that if the only way China can stimulate the economy is through investment, then China's $3 trillion in foreign exchange reserves will be exhausted within 5 years.

She says speculation is the greatest threat to China's development and this speculation could exhaust China's reserves. Although China has $3.2 trillion in reserves, it isn't enough to protect it from hot money, not when the global forex market trades $5-6 trillion each day. If there is no long-term strategy to defend the reserves, they could be rapidly exhausted.

There's a definite shift in the trend in China and this is a big one that will affect global investors, not only those focused solely on China.

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