China Sells Treasuries, Yuan Falls

Patrick Chovanec has a piece in Foreign Policy explaining why China's sale of treasuries isn't bad news for the U.S., let alone the treasury market itself:

Why China’s U.S. Treasury Sell-Off Is Good News
But when the PBOC sells U.S. Treasurys, the opposite occurs. It can’t spend the dollars it receives in the Chinese economy, and if it exchanges them for yuan, it’s in effect taking money out of the Chinese economy. The PBOC can counter this tightening effect by injecting more yuan, on its own, but selling U.S. Treasurys does nothing to channel more funds into the domestic Chinese economy. Quite the contrary — it is buying reserves that expands a country’s money supply and credit; selling those reserves is (other things being equal) contractionary.

Then what good are the dollars the PBOC gets when it sells U.S. Treasurys? Though accepted around the world, U.S. dollars are fundamentally a claim on goods and services, and assets, in the U.S. economy. When China draws down its reserves, it means money wants to flow out of the Chinese economy, to purchase those goods, services, and assets from abroad.
The whole piece is worth reading.

Some information to add on, from 2010: China to use "effective exchange rate"
Caixin: The reform that started in July 2005 focused on setting the yuan exchange rate with reference to a basket of currencies. However, there are many questions about this "basket." How did PBOC choose currencies in the basket, and what are their weights?

Hu: To select a basket of currencies, some countries or agencies have taken into account a single measure. For example, the Bank for International Settlements considers the weight of foreign trade. Because the exchange rate floats mainly on the basis of supply and demand in the real economy, the current account can comprehensively reflect the real economy. While in the current account, foreign trade is the most representative factor. As a result, in the selection of currencies in the basket, trade is among the first priorities.

In our opinion, the effective exchange rate basket should have a variety of currencies to reflect diversification of trade and investment. The weight is to be determined based on the current account situation and the currency structure of capital, and the financial account, and cross-border receipts and payments. Usually, currencies in those countries with active economic relations with us or frequently used in bilateral economic activities will be selected for the basket currencies.

In 2012, I wrote Chinese yuan is down for the year, more losses coming
One of my main reasons for predicting a depreciating Chinese yuan (and I've been wrong for about 2 years thus far) is that I expect a U.S. dollar bull market against foreign currencies, and the PBOC's switch to a currency basket means it will break with the U.S. dollar. Previously, China was adding euros during the first and second round of the Greek crisis, which structurally weakened the yuan (based on my expectation of euro depreciation). The above article shows that the PBOC hadn't followed its rhetoric and is only now relying on the currency basket, which could go a long way to explain the depreciation in May. The wildcard in the basket is the yen.

Next up: Beijing’s Twisted Logic
An even curiouser pronouncement came in response to last week’s move by the European Central Bank to print 60 billion euros a month to buy government and corporate bonds. In a news conference, People’s Bank of China Vice Governor Pan Gongsheng said Friday that the flood of new euros was likely to boost China’s exports to Europe and put downward pressure on China’s yuan.

Boost exports and push down the yuan? It is a most provoking thing when a person doesn’t know a cravat from a belt.

For starters, printing 60 billion euros a month is a sure-fired way to weaken the value of the euro against any currency whose supply isn’t increasing at an equivalent rate.
As far as I can tell, Pan Gongsheng didn't say against which currencies the yuan would depreciate. Since the USDCNY cross is the most closely watched, I assume any non-specified talk of depreciation and appreciation is against the U.S. dollar.

China does have an incentive to further weaken the yuan though:
Traders violate this peg at their peril, for the PBoC has used money-printing for years to buy up nearly $4 trillion dollars to keep the yuan from rising. It can now sell those dollars if necessary to keep the yuan from falling.

In fact, it has been. With its own economy weakening, the property market falling and Beijing declaring open season on official corruption, money has been seeping out of China for months. So despite rising exports China’s foreign-exchange reserves have dropped 3.5% since June, to $3.84 trillion. The PBoC isn’t mounting a very determined defense, however. Despite selling off some of its dollar hoard, it has nudged the yuan 2% lower against the U.S. dollar since late June.

...A weaker yuan would make China’s exports cheaper overseas, helping China maintain market share against Japan, whose central bank is printing up to 80 trillion yen a year to boost exports. It would also help shore up exports to Europe, China’s second-largest export market after the United States.

Pan may have simply scrambled the order of events when he suggested a weak euro would help China’s exports and weaken the yuan. It’s surely the other way around: China will weaken the yuan and support exports to Europe.
Both are true. The Chinese central bank can take advantage of a falling euro to diversify away from the U.S. dollar, as it did during the prior rounds of the European sovereign debt crisis. The goal may not be to devalue the yuan, but as the euro share of reserves rises and the Chinese reform the financial system, the market increasingly determines the direction of the yuan and that value is increasingly tied to the EURUSD cross. The Chinese buy yuan, propping up the euro versus the dollar, while devaluing the yuan versus both. Then if the euro (and other currencies) tumbles versus the U.S. dollar, the yuan decouples from the dollar and recouples with the non-dollar currencies.

Weak yuan not a product of ‘engineering’
China isn’t trying to engineer yuan weakness, unlike what happened in the first half of 2014, and will push back against the weaker spot rate through fixings, Brown Brothers Harriman & Co strategists led by Marc Chandler wrote in a note yesterday.

The Bloomberg Dollar Spot Index rose to the highest level in data going back to late 2004 as the euro tumbled after the European Central Bank announced a bond-buying program last week. PBOC Deputy Governor Pan Gongsheng said the ECB stimulus was adding to depreciation pressure on the yuan.

This isn't helping matters: Clients urged to be wary as deposits vanish
Cases in which clients' bank deposits have disappeared have triggered a call for Chinese banks to strengthen internal management and for depositors to be wary of interest rates that are much higher than benchmark figures.

In several widely reported cases, criminals colluded with bank clerks or executives.

They lured clients with high deposit rates, provided them with false information and later transferred the clients' money to criminals' accounts.

Zhao Xijun, deputy dean of the School of Finance at Renmin University of China, said, "Banks must improve supervision of their operations to prevent their clerks from doing illegal business while keeping other people in the dark."

The cases reported include the embezzlement of 95.05 million yuan ($15.26 million) from 42 depositors at a rural commercial bank in Hangzhou, Zhejiang province.

Chinese investments in overseas real estate increased by 46 percent to a record $16.5 billion in 2014, as China’s slumping property market combined with regulatory reforms to send its investors across borders in search of deals.

For the first time ever, Chinese buyers have spent more on commercial real estate outside of China than domestically in 2014, according to a report released today by property consultancy JLL, as outbound acquisitions of office and retail space jumped by nearly half compared to the previous year.
China could slam the door on these flows, but it has actually been encouraging them in recent years: Lenovo Heeds Jiang’s ‘Go Out’ Call in Second China M&A Wave
Fifteen years ago, China initiated a “Go Out” policy that encouraged state-owned companies to acquire overseas energy and mining assets to feed an emerging export juggernaut.

Today a new generation of Chinese buyers has emerged: private companies led by deal-hungry entrepreneurs. Rather than looking for natural resource deals, firms like Lenovo Group Ltd. (992), Fosun International Ltd. (656) and Dalian Wanda Group are pursuing everything from computer servers to movie theaters and brand names like Club Med.

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