2017-05-31

Renminbi Will Decline Because China Is De-dollarizing Amid Dollar Deflation

Go read the whole thing.
Balding's World: Can China Address Bank Problems without Having Currency Problems?
I believe there is a much larger structural demand for foreign assets by Chinese citizens/firms in virtually any scenario than there is for Chinese assets by foreign firms/citizens. There are many reasons for this but it is simply very difficult to see where this structural demand tilts towards net inflows into China.
I can see one scenario based on history: Japan 1985, Plaza Accord. Canadian home prices look as though they've topped. Australia should be next. San Francisco may have peaked. U.S. stocks might be peaking, at least in relative terms. If (big, big if) RMB is rising, Chinese home prices are rising, A-shares are rising, foreign assets are topping or falling, then I could see China having a final crack-up boom. How likely is that? Not very. The other scenario is a top in the dollar. I don't expect it, but a new bear market in the dollar (signaling global credit expansion is resuming) would prop up the yuan against USD, though it would slide against nearly everything other currency.
Furthermore, and this is something that is poorly understood by many many people, is the virtually every debt is perceived as being backed by the government by Chinese investors. I want to emphasize this does not mean they have technical or even implicit state backing but from sophisticated institutional investors to small scale retail punters, there is a wide spread belief (which Beijing while officially denying in practice has not given people reason to behave differently) that virtually every debt product has a state guarantee. The simple reality is that in the event of a financial event that requires public action, large sections of “private” Chinese debt will simply be absorbed by the state. Now with total depository corporation asset of 316% of GDP at the end of 2016, it wouldn’t take a large bailout as a percentage of total asset to take Chinese central government debt soaring into Grecian territory. An explosion in government debt financed via some of the various channels here is possible but it is important to note there are greater constraints there than generally realized and the impact it would have on the RMB.
Everyone in China believes this. They have to bailout the whole system, or risk total panic. Related to that from ZeroHedge: Fitch Warns Baidu Faces "Default Risk" Due To Growing Shadow Banking Business
Baidu, China’s dominant search engine, has not been immune to the scramble for funding optionality provided by shadow banking alternatives, and has been getting into the WMP game by rapidly expanding its Financial Services Group, which Fitch says is increasing Baidu’s overall business risk.

While Baidu is not under obligation to pay the returned target on these products, a failure could be potentially damaging to Baidu's reputation, Fitch warned.

“As with Chinese banks, Baidu does not need to set aside large capital against potential defaults on its WMPs … WMPs have become an alternative form of financing for projects or investments that would not qualify for bank loans,” Fitch said.
Chinese believe all of this paper is ultimately backed by the PBoC and CCP. Also, Chinese tell me: "The government will never let home prices fall."

The other part of this is China has begun De-dollarizing. As I've argued before, and I believe it is playing out as expected, the U.S. dollar system dies by deflation, not inflation. The dollar system is broken because the U.S. economy cannot finance global economic activity that includes China and India. Many analysts got it wrong predicting hyperinflation because they thought the U.S. dollar would inflate away during an expansionary phase. Except this is exactly what the world demands: cheap credit financed with a weak U.S. dollar. Instead, they are struggling to with tight liquidity because the global financial system isn't creating enough dollar (eurodollar) credit.

The breakpoint for the dollar system is when countries such as China throw in the towel because they can't get enough credit from the dollar/eurodollar system. They start financing a credit expansion/bailout solely in yuan terms. When will this happen? It has already begun.

Alhambra: Stuck Between Dollar And De-Dollar
When crisis first struck China in the middle of 2008, there were two RMB of foreign reserves for every one RMB in bank reserves. That was not by accident, as even under the more flexible currency regime following the partial float in July 2005 the PBOC endeavored to maintain such a cushion for legitimacy and therefore stability. The global eurodollar markets, however, stopped cooperating so that in the years of “recovery” since then the Chinese central bank has been essentially diluting RMB.
They would have to balance their “dollar” problem against RMB growth of however much. Bank reserves were put back on an upward trajectory last February, but it wasn’t the same as in the prior period. Constrained by again overall dilution potential, China’s internal monetary policy has clearly sought to balance the two conditions, the result of which has been a large injection of RMB but not so large as to totally de-dollarize.
If they have to bailout the financial system it would require far larger injections, orders of magnitude larger.

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