Signs Point to Lower Yuan, But US Treasury Wants Appreciation

Today I came across this headline in Chinese that says "Foreign Media: Two Graphs to Understand Why China's FX Reserve Growth Tumbled 99%" 外媒:两张图看懂中国新增外汇占款为何暴跌99%. I can't find the foreign media source, but the article looks at FX reserves and the renminbi. It's a topic I've covered this many times on the blog: when China's FX reserves stop growing, the yuan depreciates. FX reserve growth ground to a halt in May. In looking for the source, I came across this article:

U.S. to fire early warning shot at China over currency
The U.S. Treasury is expected to put pressure on China over recent weakness in its currency during high-level meetings in Beijing this week.

Before leaving for the Beijing talks, Treasury Secretary Jacob Lew expressed concern over China’s foreign-exchange intervention. Lew said China seemed to follow a path of “two steps forward and part of a step back” on the exchange rate. Although the yuan has appreciated by 14% since 2010, it “still needs to appreciate more, it is undervalued,” Lew said.

Nicholas Borst, an economist with the Peterson Institute for International Economics, said that the U.S. wants to send “an early warning shot” at China in order to put a floor under depreciation. While some of the weakness of the yuan appears to be market driven, some is “policy-driven,” Borst added.
Maybe the Americans are applying political pressure. Or maybe they are totally out to lunch.

Yuan slips as Chinese oil giants buy dollars
The PBOC's foreign exchange assets rose a minor 361 million yuan ($58.21 million) in May, down sharply from an 84.6 billion yuan rise seen in April and the lowest growth in 11 months.

The increase and decrease in the central bank's forex assets, which mainly reflect its foreign exchange purchases and sales on the yuan market, clearly show that the monetary authorities have recently sharply reduced their intervention.

The headlines say the Americans want PBOC intervention to push the yuan higher, but the PBOC wants to let the market play a greater role. Given the current state of affairs, the market will eventually take the yuan lower.

Another possibility is that the PBOC is still intervening, but it is propping up the yuan. This happened in late 2011 and into 2012, which was the last time the real estate market cooled in China.

From March 2012: Yuan to face downward pressure in 2012
The domestic situation was also changing, he said, as the past pattern of fiscal expansion will not continue.
"In that respect, the change will be reflected in a dive in the investment growth rate, which will drop to about 12 percent - the level when (former premier) Zhu Rongji led the cabinet - from about 23 percent in recent years," Liu said.

Judging by figures for new yuan loans by banks, which have been running below expectations, the tendency was very clear, he said.

Despite these trends and changes, he said, the yuan might not depreciate this year. The central bank will use its dollar holdings to support the currency if necessary, he said.

Back in July 2012 there was this article in Chinese about hoarding of dollars: 囤点美元. I translated this bit:
Everbright Securities macroeconomic analyst He Yuanyuan found in the fourth quarter of last year and April this year, the central bank bought yuan and dumped foreign currency (expressed as a reduction in the total of foreign currency assets). This shows that China's central bank is in the market to support the RMB exchange rate, to prevent it from excessive devaluation. This shows from another perspective, the pressure of RMB devaluation.

Here's a look at the yuan devaluations in 2011 and 2012 again, but with the yoy growth rate. It makes for a clearer picture. I've put two real estate headlines in there, one from the first case of real estate rage (to my knowledge) in Shanghai October 2011 and then again in Hangzhou February 2014.

If the Americans seriously believe China can appreciate the yuan in this environment, then there is going to be a political confrontation because from the looks of things, China is going to have to intervene to slow yuan depreciation. The rehypothecation scandals put pressure on the yuan because many loans were foreign currency loans, and in the case of gold, it was mainly an arbitrage between onshore and offshore interest rates. The borrowing and these arbitrage trades pushed the yuan up, removing them will push the yuan down.

For now the trade surplus is helping: Offshore Yuan Rises to Three-Month High on Trade Surplus Outlook. The actual data comes out later this week. Even with strong trade data though, Chinese exporters do not have to bring their cash onshore; they can keep their forex holdings in overseas bank accounts. As of yet there's no dollar or forex hoarding as was seen in 2012.

The overall conditions in the economy are worse than in 2011/2012. The psychology of the yuan market is better than in 2012 when the topic of selling yuan was widely discussed in China. The yuan might climb this week for a political show, but longer term the odds favor depreciation.

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