Presenting 3 Chinese "Endgame Scenarios"

As we’ve tried to make abundantly clear in the wake of China’s adoption of a new currency regime in August, Beijing’s attempt to strike some kind of illusory compromise between a free floating currency and a currency that’s completely controlled by the PBoC was doomed from the word go. “Whereas the daily fix was previously used to fix the spot rate, the PBoC now seemingly fixes the spot rate to determine the daily fix, [thus] the role of the market in determining the exchange rate has, if anything, been reduced in the short term,” BNP’s Mole Hau wrote last month, and as we said then, less of a role for the market means more of a role for the PBoC and that, in turn, means burning through FX reserves. 

Complicating the situation further is the fact that FX reserve drawdowns work at cross purposes with RRR cuts by sucking liquidity from the market meaning each intervention necessitates some manner of short-term liquidity injection (e.g. reverse repos, etc.) or else more RRR cuts.

Of course policy rate cuts and liquidity injections are seen by the market for what they are: attempts to ease. And unfortunately for China, that’s true whether or not the net effect of the push and pull on money markets is easing or not, and that perception on the part of the market leads to downward pressure on the yuan at which point the entire thing starts over again in a nightmarish, FX reserve-depleting circle.

Add in stepped up efforts to close the gap between the onshore and offshore spot and you have yourself a rather untenable situation and as with all things untenable, there will, sooner or later, be an endgame. 

Against this backdrop, we present Daiwa’s list of China’s three possible endgame scenarios (via Bloomberg): 

China’s balance sheet under serious contractionary pressure as money leaves and Fed decision looms, resulting in three endgame scenarios, Daiwa analysts Kevin Lai and Junjie Tang write in note dated Sept. 9.

• Scenario 1: PBOC actively intervenes by selling FX reserves to support CNY; a painful credit crunch ensues; companies come under pressure to liquidate assets to pay debts in classic case of “debt deflation”
• Scenario 2: Govt. stops FX intervention and prints massive amounts of money; interest rates and reserve ratio potentially slashed; moves put significant downward pressure on CNY and implications of a currency crisis would be global 
• Scenario 3: China muddles through between scenarios 1 and 2, where PBOC tries to manage an “orderly” downward adjustment for CNY; stimulus wouldn’t ultimately be large enough to have any meaningful impact

So the commentary on Scenario 1 there seems to suggest that ultimately, China will not be able to wholly or effectively offset the liquidity crunch caused by the FX reserve burn, triggering a contractionary nightmare. Scenario 2 looks like a rehash of Citi's recent suggestion, which for those who missed it (or for anyone in need of some Thursday comic relief), was this: 

As regards funding the fiscal stimulus, only the central government has the deep pockets to do this on any significant scale. The first-best would be for the central government to issue bonds to fund this fiscal stimulus and for the PBOC to buy them and either hold them forever or cancel them, with the PBOC monetizing these Treasury bond purchases. Such a ‘helicopter money drop’ is fiscally, financially and macro-economically prudent in current circumstances, with inflation well below target and likely to fall further.

Scenario 3 is probably what will end up playing out, but frankly, it's not entirely clear that 3 is that much different from 1, because as we noted at the outset, the market doesn't like the whole "orderly downward adjustment" idea, precisely because it telegraphs further devaluation which leads traders to speculate on more yuan weakness and that speculation necessitates more reserve liquidations. 

In short, the only "scenario" that doesn't result in an "endgame" is for everything to suddenly be fixed overnight, or, as SocGen recently put 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." That, obviously, is laughable so all we can say to the PBoC (and also to the Fed, who must consider all of the above when weighing liftoff) is "good luck."

Comments

[RaceToTheBottom]

This article seems to be way over my head (especially after the Oregon Pino) but I would have thought that increasing a countries gold reserves (as china has been doing) would have had positive effects on their currency.

[Things that go bump]

I could be wrong, but I believe their currency is backed by Skittles produced from the rear ends of magic unicorns, just like the rest of the currencies. 

[angel_of_joy]

You ARE wrong. Their currency is backed by a manufacturing economy...

[MSimon]

The USA is the 2nd largest mfg economy in the world - if you believe Chinese stats. We have 1/4 the population. Do the math.

[ThirteenthFloor]

You do the math Simon, trade/account balance by sovereign state. China leads the globe, America heads bottom of the list.

https://en.m.wikipedia.org/wiki/List_of_sovereign_states_by_current_acco...

[angel_of_joy]

Keep repeating that. Someone might believe you... eventually. Just out of personal curiosity, what exactly is USA manufacturing nowadays other than some decent civilian aircraft (Boeing), some unexportable cars (made by The Three Stooges), and some overly expensive (and not particularly efficient) military hardware ?

[earleflorida]

does anybody remember this scenario...        http://en.wikipedia.org/wiki/Dot-com_bubble                 http://en.wikipedia.org/wiki/1997_Asian_financial_crisis     http://atimes.com/2015/09/thailands-enshrinedeconomic-malaise-militancy/                 

all within a tymeframe of these and those scenario's....             http://en.wikipedia.org/wiki/Enron         

and juggling the past scenario with a China that's in real-tyme moar solvent than the USSA is a red-herring, aka. fool's errand

Pakistan gets its Nuke's Program up and running full-tyme, and '911' happens... and? China joins the 'WTO' in Dec/2001 via Bush #43 blessings

[LawsofPhysics]

What part of ALL fiat will die don't people understand?

[Seasmoke]

the ALL part......the USD will live forever it seems

[Oldballplayer]

And forever lasts forever. Until it's now.

And then it dies.

[negative rates]

If not the whole thing is born again and starts over all again, a concept missed by those who don't do all the what ifs.

[negative rates]

If not the whole thing is born again and starts over all again, a concept missed by those who don't do all the what ifs.

[negative rates]

?

[negative rates]

Prolly both the fiat and the dying parts, real denial these reactive mooks live by.

[alphahammer]

What part of "value of anything/everything" do people not understand?

[Commodore Decker]

Fiat will never die. It is religion now. The reset will be blamed on the free market that never was free in the first place. The muppets cannot begin to understand how high their standard of living would be today if we had a gold standard. Its inconceivable to them. There will be more and more .gov until everyone is a slave in their corporate cubicle farms or chained to an espresso machine.

[rsnoble]

No worries, read here or somewhere else dont recall, that one of the US's top manipulators is in route to China.  They need kick the can education in the most urgent way.

[earleflorida]

Larry Fink gets that prize!

http://www.senseonecents.com/2010/03/larry-fink-the-king-and-his-kingdom/

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aP8IpRzYSu2o

and this where it landed... 

http://fortune.com/2010/09/07/as-bob-diamond-takes-over-barclays-the-only-surprise-is-that-people-are-surprised/

dimon v. diamond with a fink taking the prize

hope it helps

[bid the soldier...]

You're talking about Larry Fink, no doubt.

BlackRock's massive $4.3 trillion in assets under management may actually understate the influence of the world's largest money manager. 

PBoC invited Fink to China to discuss the possibility BlackRock assuming Goldman Sach's position in the Shanghai Stock Market, after they bust GS out of all of its trades (now mostly short and profitable) and then boot Blankfein's harry ass out of Asia.

BlackRock would appear as the originator of these trades and would politely wait until they were not as profitable before they were covered.

The Central Bank of the soon-to-be largest economy in the world would be extremely grateful, and everyone at ZH and BlackRockknows what that means.

And if Blankfein gives the Shanghai Exchange any problem, GS can look forward to a 9 or 10 to 1 exchange rate when they move their yuan back to dollars.

[MSimon]

Blankfein's harry ass

You have seen Blankfein's ass? Interesting.

[bid the soldier...]

Shiny scalp. Harry ass.

Male Pattern Baldness

I wonder what you're flaunting at both of your ends?

Do you exhibit on Instagram?  :oD

[Usurious]

Mako2010---'Those china men will be going back to the rice patties on the bicycles they road in on.'

http://www.zerohedge.com/article/stunner-china-set-announce-record-trade-deficit-march

[decon]

I miss Mako, Trav777 and Crash is Optimistic.  At least Mscreant is still around.

[Escapeclaws]

Ii miss Akak and Escapeclaws.

[will ling]

let's cut thru the "scenario" bs:

in 1973 , when daniel moyihan ( the domestic policy advisor to nixon), who was a pretty smart guy whatever you thought of his politics, was asked what he tought of the nixon/kissinger "breakthrough" to china. he said " well, if you think that we'll all be speakin' chinese in 50 yrs is good, it's good."

moyihan was maybe 10-20 yrs off, but otherwise, right on.

[venturen]

the only thing worse than Capitalism Cronyism is Communisit Cronyism...and well yes Socialist Cronyism...though we are making a good go of it....the politcal power will swing...and hopefully some bankers

[cougar_w]

I think the Chinese will do what the US and EU will do, being what anyone with a printing press will be doing soon; print hard enough to wake the dead. They'll print like mo'fos, print like mad men, print like fly pimps. Print until their eyes bleed.

I've been saying that for over 3 years. And they have done exactly that. And they will continue.

I am now looking for evidence that they are injecting actual cash into local economies. Just giving it away here take some go buy shit. If you think that's inflationary then just you watch what happens. We are in the grips now of a devouring deflationary vortex sucking all value out of ever corner of the financial universe. Money is dying, or really being set on fire and burning to ashes. $Trillions vanish in August alone. Tens of $Trillions will evaporate over the rest of 2015. Debt money will implode on itself and anyone holding a tangible asset -- be it land or gold or commodities or water or oil in drums -- is going to be a target for undesired State attention.

And when the dust is settled in a generation hence it's going to have become  another unbelievable episode among the ages of men.

[Not My Real Name]

"Money is dying ..."

Worthless fiat currencies are dying. Money doesn't die. In fact, my money at the bottom of the lake is doing just fine, thank you.

[bid the soldier...]

It does too die.  And after it dies, it goes to money heaven.

Just ask Art Cashin, smarty.

[angel_of_joy]

I had about enough of this "deflation" BS. Deflation is a false problem because it dissapears over night, the moment you decide to default on your debt. Better ask yourself why is nobody interested in even mentioning the word DEFAULT (or debt restructuring, be it full or partial...) ?? The answer to that particular question will tell you all you need to know about who is really in charge...

[enloe creek]

Watch auto contracts for some sign. They are going pretty well and a signing bo us of mid 4 figures is indicated

[richiebaby]

Speaking about a game. 

Ben Roethlisberger said before the game:

"I'm dedicating this game to my idol Bill Cosby"

[Steve556]

I read zerohedge for a few years now.   The quality of articles has fallen off a cliff.  Used to be a quality site , writers able to articulate their ideas clearly with logic and insight.     Now Nothing but lunatic babbling.  

[angel_of_joy]

So true... RIP !

[Yen Cross]

 The nuclear option was never about blowing people and structures up.

 I'm flat. I closed all my trades before Labor Day.

  When you have spare time, think about how you would use time to be better prepared.

 Open some books, and enjoy nature.

[stock market loser]

Banks will own us until we riot in the streets with our guns. 40 million and growing. When tshtf bankers will be shot on site or will be  in private planes to their bunkers abroad. 

[Wild E Coyote]

You mean The Bankers, or the Guys working in the Bank?
Good luck finding the Bankers.

[Consuelo]

Wake me up when China does something meaningful with all the gold they have.   You'll know it's on then.

[8th Estate]

• Scenario 4: China dumps the remainder of their US Treasuries, forcing the Fed to do massive QE4 to hoover them up. The petrodollar tanks and massive price inflation takes off in the US. As this gets underway, China shockingly reveals 20,000 tons of gold and revalues it to the equivalent of $10,000/oz overnight by offering to pay that price to its people for turning in their bullion. They obey in enormous numbers and the Chinese government reports 30,000 tons within a month. They immediately implement a gold standard and print Yuan. The Krugman Food Riots begin in America.
  

[geekz_rule]

yep. I was going to post.. these last few weeks seem to me.. they are just fucking the west, on purpose, offering cover... for the final end of petro dollar and us hegemoney. of course it isnt... china vs west.. the oligarchs are still in control and have already moved accordingly. nothing chnages for them.