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"We Do Not Think This Is Sustainable": Barclays Warns On Massive Cost Of China's FX Intervention

Tyler Durden's picture




 

One of the most important things to understand about China’s doomed attempt to simultaneously manage the stock market, the economy, a deleveraging in some sectors, a re-leveraging in others, and the yuan is that it’s bound to produce all manner of conflicting directives and policies that trip over each other at nearly every turn. One rather poignant example of this is the attempt to rein in shadow lending without choking off credit growth. Another - and the one that will invariably receive the most attention going forward - is the push and pull on money markets by the PBoC’s FX intervention and offsetting liquidity injections. 

Recall that Beijing’s open FX ops in support of the yuan necessitate the drawdown of the country’s vast store of USD reserves. In other words, they’re selling USTs. The effect this historic liquidation of US paper will have on global liquidity, core yields, and Fed policy has become the subject of fierce debate lately although, as we’ve been at pains to make clear, this is really just a continuation of the USD asset dumping that was foretold nearly a year ago when Saudi Arabia killed the petrodollar.

In any event, when China liquidates its reserves, it sucks liquidity out of the system. That works at cross purposes with the four RRR cuts the PBoC has implemented so far this year. In short, Beijing, in a desperate attempt to boost lending and invigorate the decelerating economy, has resorted to multiple policy rate cuts, but to whatever degree those cuts freed up banks to lend, the near daily FX interventions undertaken after the August 11 deval effectively offset the unlocked liquidity. 

What this means is that each successive round of FX intervention must be accompanied by an offsetting RRR cut lest managing the yuan should end up completely negating the PBoC’s attempts to use policy rates to boost the economy - or worse, producing a net tightening. What should be obvious here is that this is a race to the bottom on two fronts. That is, the more you intervene in the FX market the more depleted your reserves and the more you must cut RRR until eventually, both your USD assets and your capacity to deploy policy rate cuts are exhausted. There are only two ways to head off this eventuality i) move to a true free float, or ii) implement a variety of short- and medium-term lending ops to offset the tightening effect of FX interventions in the hope of forestalling further RRR cuts. Clearly, this is a spinning plate if there ever was one, as attempting to figure out exactly what the right mix of RRR cuts and band-aid reverse repos is to offset FX interventions is well nigh impossible. It’s against this backdrop that Barclays is out with what looks like one of the more cogent attempts yet to outline and illustrate the above and explain why it simply isn't sustainable. Below, find some notable excerpts. 

First, here’s Barclays explaining what we’ve said for weeks and what BNP recently highlighted as well, namely that while the PBoC used to manipulate the fix to control the spot, it now simply manipulates the spot to control the fix, which in fact leads to less of a role for the market, not more:

Since China’s FX policy change on 11 August, spot CNY has traded close to the daily fixings. However, this apparent success may have come at a heavy cost. While the daily USDCNY fixings are more aligned to the previous day’s close, the close itself appears not to fully reflect market forces.

Of course less of a role for markets means more of a role for the PBoC, and that means FX reserve liquidation. There’s been no shortage of attempts to quantify the burn rate, but for what it’s worth, here’s Barclays estimate:

Our analysis suggests that the PBoC stepped up its FX intervention to USD122bn in August, from ~USD50bn in July, which underscores the significant pressure from capital outflows. Nonetheless, this suggests that the recent relative stability of spot USDCNY could be misleading. Based on the available data for FX intervention in July and our estimates for August, the PBoC has spent around USD172bn on intervention in both July and August. While the PBoC has huge FX reserves (USD3.65trn as of July 2015), if the current level of capital outflow pressures is sustained, we believe this currency defence could become costly. If the pace of FX intervention remains at USD86bn per month, we estimate that the PBoC could lose up to USD510bn of its reserves between June and December 2015, which would represent a nonnegligible decline of 14%.

 


As should be clear from everything said above, FX interventions and liquidity injections are, as Barclays puts it, simply two sides of the same coin, and to the extent the interventions continue, so too will the liquidity ops. Here’s an in-depth look:

So what's the solution? Well, there isn't one. As Barclays concludes, until expectations of further yuan weakness subside, the situation can't stabilize: "We do not think the present policy is sustainable given the associated costs in terms of FX reserves depletion and liquidity imbalances [and] as such, we maintain our view that the CNY will need to depreciate further to stabilise capital outflows; we forecast a further 7% fall by year-end."

So unless suddenly everything is fixed or, as SocGen puts it, "for the RMB to appreciate compared to its current value will require a very positive environment for EM coupled with a cessation of capital outflows and a vibrant cyclical growth and an export recovery," the road ahead looks rather precarious, and not just for China, but for the Fed and by extension for the entire global economy. And on that note, we'll close with what we said earlier this week:

As the Fed debates whether or not to hike, and how much, the acceleration in Chinese capital outflows starting on August 11 has set the path for the Fed, and at this point any incremental delay in hiking merely adds more to the already vast cross-capital and currency confusion around the globe. However, no longer is the Fed's quandary open ended: with every passing day, China is suffering incremental tens of billions in capital flight and reserve liquidation, and thus, tighter global financial conditions, as can be expected from the unwind of the world's largest depository of USD-denominated reserves.

 

Finally, what all of this really means, is that having pushed China to the point of dissociating itself from the USD peg officially, the more the Fed tightens, the more China will have to push back through devaluation or otherwise, and the more capital outflows it will be subject to, thereby amplifying the Fed's tightening posture around the globe. In this very unstable arrangement, suddenly the smallest policy error will reverberate exponentially, and result in the only possible outcome: the Fed's admission of policy failure by adopting a tightening bias, and ultimately launching another phase of monetary easing, be it QE4 or perhaps even the long-overdue and much anticipated Friedmanesque "helicopter money" episode.

 

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Sat, 09/05/2015 - 18:19 | 6514097 goldhedge
goldhedge's picture

Its only fucking useless paper.

Sat, 09/05/2015 - 18:23 | 6514105 Carpenter1
Carpenter1's picture

This is called a narrative. We are being prepared to accept a market crash due to "unforseen circumstances."

 

Different day, same old tricks.

Sat, 09/05/2015 - 18:43 | 6514114 knukles
knukles's picture

Couldn't have seen that coming now, could we?
It's that Chink Bush's fault.

And now for a bed time story, kiddies.  Once upon a time there was a president named Bill who gave all our country's secrets away to the Commie Rat-bastards, the Chinks.  Which would have made him the first Chink president, but he already said that he was the first black president, so the next president, Able George was inaugurated as our first Chink president.  And that's what makes America Great.  Because in America if you want to be president you can be president of anything you want to be, whether by vote, force or just making shit up.. 

Now, let's all sing the Happy Happy Joy Joy song and celebrate Labor Day in this great country where most people don't work  (Sigh)

https://www.youtube.com/watch?v=jfNajFYPljQ

                         Don't worry, the shit'll all buff out

Sun, 09/06/2015 - 05:20 | 6514773 Keyser
Keyser's picture

What better way to divest themselves of UST's than to burn them in supporting their economy during the re-factoring, aka reset... With the psychotic rhetoric coming out of DC, the faster the better... 

Sat, 09/05/2015 - 18:19 | 6514100 straightershooter
straightershooter's picture

what is the best way to unload US dollars, soon to be devalued?

Sun, 09/06/2015 - 03:07 | 6514730 MSimon
MSimon's picture

Burn them.

Sat, 09/05/2015 - 18:22 | 6514103 gwar5
gwar5's picture

China can devalue their Yuan, cash in their USD treasuries, then revalue their Yuan back up again. Repeat. FED's pissed coz they thought only they could do shit like that.

Sat, 09/05/2015 - 18:31 | 6514118 KnuckleDragger-X
KnuckleDragger-X's picture

A command economy assumes that you can control the outcome. The problem is they are playng in the world economy and right now that is contracting. Selling off ther FX reserves is, at best , a short term fix and if the rest of the world won't buy their shit, it won't matter what the Yuan does......

Sat, 09/05/2015 - 18:23 | 6514106 Cosmicserpent
Cosmicserpent's picture

What's to prevent the Fed from raising rates, buying these UST's from China, and shoveling them directly into the stock market?

Sat, 09/05/2015 - 18:32 | 6514119 KnuckleDragger-X
KnuckleDragger-X's picture

Findng a buyer......

Sat, 09/05/2015 - 18:35 | 6514112 Insurrexion
Insurrexion's picture

Meine Droogies,

Nein Shieze.

Such a long, boring article with such pretty graphs and such busy words like China’s doomed, deleaverging, PBoC’s FX intervention and offsetting liquidity injections (very sexy), we don't tink the present policy is sustainable, China is suffering incremental tens of billions in capital flight and reserve liquidation and the author congratulating demselves on how prescient dey are... with the typical "I told you so" attitude. Scary Shieze!

Fuck dat.

I want to know when das fucker crashes so I can fit it in my schedule between fucking, licking, piercing, biting, screaming, sucking, humiliating and kicking banker's asses for large amounts of fiat currencies.

Cans I gets a vitness Tyler?

Love, Alexa

(you will sooner or later Bitchez)

Now, let's Danse!

https://www.youtube.com/watch?v=KLxqm7ey4Nw

Sat, 09/05/2015 - 18:39 | 6514125 lordbyroniv
lordbyroniv's picture

niiiiice

Sat, 09/05/2015 - 21:39 | 6514419 Rodent Free Corps
Rodent Free Corps's picture

No "Pet my monkey" there, Sprockets?

Sat, 09/05/2015 - 18:35 | 6514124 Atomizer
Atomizer's picture

How are you going to bury hot money?

Sat, 09/05/2015 - 18:44 | 6514138 Atomizer
Sat, 09/05/2015 - 18:53 | 6514155 Dobermann
Dobermann's picture

And who says they want those garbage bonds? This is perfect pretext to unload useless paper.

Sat, 09/05/2015 - 18:58 | 6514160 Soul Glow
Soul Glow's picture

"The bubble has burst."

- PBoC Governer

At least he is being honest.

Sat, 09/05/2015 - 19:16 | 6514186 buzzsaw99
buzzsaw99's picture

fuck barclays. die bitchez.

Sat, 09/05/2015 - 19:46 | 6514229 q99x2
q99x2's picture

helicopter money

I heard of that before but ya know. Just my luck none ever fell on Q99X2. 


Sat, 09/05/2015 - 20:07 | 6514271 ThroxxOfVron
ThroxxOfVron's picture

"Our analysis suggests that the PBoC stepped up its FX intervention to ***USD122bn in August, from ~USD50bn in July,*** which underscores the significant pressure from capital outflows. Nonetheless, this suggests that the recent relative stability of spot USDCNY could be misleading. Based on the available data for FX intervention in July and our estimates for August, the PBoC has spent around USD172bn on intervention in both July and August. While the PBoC has huge FX reserves (USD3.65trn as of July 2015), if the current level of capital outflow pressures is sustained, we believe this currency defence could become costly. ***If the pace of FX intervention remains at USD86bn per month, we estimate that the PBoC could lose up to USD510bn of its reserves between June and December 2015, which would represent a nonnegligible decline of 14%.*** "

$86B X 6months = $516B 

$516B = approx 14.137% of $3,650B

...@ a burn rate of $86B per month China will exhaust ALL FX Reserves in less than 43 months.

 

$122B X 6months = $732B

$732B = approx 20.055% or $3,650

@ a burn rate of $122 per month China will exhaust ALL FX Reserves in less than 30 months.

...sometime late evening on the day after Christmas Day 2018...


Sat, 09/05/2015 - 23:27 | 6514557 Yen Cross
Yen Cross's picture

So I'm reading the 'fine blue print'

 

 Those charts are 3 months old.

 Figure #8 SLO and the chart figure #9 slo chart don't add up.

 Figure #9 chart implies 200cny which is impossible when you factor in the RHS curve on the left chart.

 The charts are NOT synched.

 The charts are from different dates.

Sat, 09/05/2015 - 23:29 | 6514560 bnbdnb
bnbdnb's picture

Time to fake the bid

Sun, 09/06/2015 - 01:36 | 6514663 Wild E Coyote
Wild E Coyote's picture

It is wrong to think that China is trying to boost its economy, and will do anything to achieve it. 

China is punishing anyone who is converting their holding of Yuan into dollars. By reducing the value of Yuan.

China is also preparing for the future by selling Yuan to Russia for Oil and Gas.

Those who cannot see all this, I call them western economist.

 

 

Sun, 09/06/2015 - 06:51 | 6514805 outlaw.guru
outlaw.guru's picture

There is a solution to this, just not a likely one. As US began this crazy adventure, US should end it. Give $15000 (maybe even 150k :D) to every citizen of US and raise rates to 10%. This should unwind QE and devalue the USD. All those loans and carry trades in EM should be made cheaper. And USD goes down to history as a good guy, taking a bullet for the world. Chinese exports however remain a bit of a problem, but a high level of USD devaluation would provide an easy road toward making a consumer society in China.

Sun, 09/06/2015 - 07:46 | 6514841 Dr. Bonzo
Dr. Bonzo's picture

There's this neverending "oh the Chinese are hoarding mountains of gold" mantra that's very popular on ZH. In the same breath we hear how Hong Kong is the clearinghouse for a majority Chinese gold transactions. I've been saying for months now that the Chinese retail shopper who was in hour-long queues to buy gold @ 1900 has evaporated now gold is at 1150. But don't take my word for it:

http://www.scmp.com/business/companies/article/1855090/chow-tai-fook-cha...

Yes. The masses do get it wrong all the time. The gold shops are empty. I couldn't think of a better time to start buying now I have two confirmations. Gold is trending at the bottom of its range, and the maddening crowds have evaporated. I'm happy buying at 1150, and if gold goes to 800, I'll buy more faster.

 

Sun, 09/06/2015 - 11:17 | 6515256 Hope Copy
Hope Copy's picture

FYI:  27 kilos to a $1m.  Sort of hard to move and there is still risk when leaving a country.   Paper and electronic is so much easier and that is what the Chinese government wants..  It is letting 'the thieves' leave the country with US Tresuries and US bonds and that all ends up in the US eventually..  That is the disaster.  'Birds of a type flock together.'  Figure that one out, but then you just have to tread my comments if you like diggging through them.

Sun, 09/06/2015 - 11:31 | 6515290 falga
falga's picture

China has no choice but to devalue to export its overcapacity as well as invest at home whether it is 500 billion or 1000 billion of its reserve is not the issue. China will do whatever is necessary to stem the capital outflows as China's rich are moving...

Sun, 09/06/2015 - 13:39 | 6515696 Chuck Knoblauch
Chuck Knoblauch's picture

Why is China playing the white man's game?

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