China Throws a Log Onto the Bears' Fire: Signals RRR Cut

ZH: As Markets Brace For Beijing Easing, Chinese State Media Unveils 25bps RRR Cut Before Year-End

The cut in December 2019 didn't help.

How about in April 2018, did that work? Not so much. Whistling Past the Crisis: Dollar Pressure Breaks PBoC In 3 Months. What I wrote then:

That date is important. China cuts the RRR because liquidity in the financial system is tightening amid deleveraging efforts and global disinflationary forces. The pressure became extreme back in 2015-2016 when U.S. dollars were flowing out of China. February 2016 was the bottom of the 2014-2016 deflationary wave. The best explanation for the end of that wave is China's decision to flood its financial system with new credit, increasing risk with every increase in leverage. Now that credit wave is over.

China may have hoped their targeted RRR cut would be the boost needed amid the "deleveraging" effort, thanks to "synchronized global growth." Global growth isn't so hot though, and neither is the Chinese economy. And so three months later, China makes a big 100 basis point cut in the RRR.

I also wrote:

This is the most important chart in the world. It doesn't matter today and it may never matter, but if it ever matters, watch out. China's forex reserves only cover 11.4 percent of M2 money supply. Put another way, at current exchange rates there are 55 RMB circulating in M2 for every USD of reserves. The claims on reserves are rising faster than China can add reserves in a slow-growth world. There are periods of relief such as the reflationary wave kicked off in February 2016, but that month reserves backed 14.7 percent of M2 and there were 44 RMB for every dollar of reserves. Today, even if USDCNY moved back to 6.9, reserves would only cover 12.5 percent of M2. China can't risk rapid credit growth because capital controls can only do so much. Increased credit growth increases the claims on reserves and intensifies any outflow pressure.

Below 9 percent coverage of M2 now.

If global growth remains slow, that could be enough to swing reserve accumulation back to depletion, ceteris paribus. It would also mean slowed GDP growth in China that would have to be offset with bigger reforms or faster credit growth. The latter would weaken CNY and increase outflow/depreciation pressure. The policy options are fading fast and only hope remains. Hope for a global economic recovery and a restart of the U.S. dollar (eurodollar) system. Right now, I don't see a restart. I see another bear market peak as in 2011 and 2014. The yuan depreciation in both of those previous deflationary waves. The next one will be larger and China will be starting from a weaker position.

Does it feel like the end of a down cycle or the start of one?

China did another cut in June 2018: RRR Cut Talk Boosts Optimism, But For How Long?

Will an RRR cut help the market? The recent history is not encouraging. The September announcement had little effect on the market. The RRR cut took effect on January 25. The U.S. stock market peaked on January 26, China saw its intraday high on January 29. The closing high was on January 24. Maybe a coincidence. China announced a more significant RRR cut on April 17. The impact on the stock market wasn't significant, but the U.S. Dollar Index would rally more than 6 percent in the next six weeks. Emerging market currencies and local currency EM bond funds still haven't reversed.

Occam's razor says the U.S. dollar bull market has impaired China's "dedollarized" balance sheet. It is a reactionary move.