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China's "Reverse QE" Could Top $1.2 Trillion, Barclays Says
Last week, we updated our assessment of capital outflows in China, noting that based on available information, it appears that outflows may have surpassed $300 billion from early July through mid-September. That figure comes from our analysis of July TIC data, Goldman’s assessment of underlying currency demand (comprised of outright spot plus freshly-entered forward contracts), and Nomura’s estimates for onshore spot intervention and offshore spot and forward meddling by the PBoC in September.
As we began to detail late last year when falling crude began to pressure the accumulated petrodollar reserves of the world’s energy exporters, and as we and finally countless others have discussed in the wake of China’s shift to a new currency regime, FX reserve drawdowns serve to tighten global liquidity and work at cross purposes with DM QE. This creates a dilemma for Fed policy as hiking rates could accelerate outflows from emerging markets thus putting further pressure on already falling USD reserves. In other words, in today’s world, a 25 bps hike by the FOMC would be amplified and transformed into something much larger once it reverberates throughout the global financial system.
Assessing how large the cumulative outflow from China may end up being is important as it proxies for the expected drain on global liquidity (or at least part of the drain on global liquidity, as we must also consider the possibility that net petrodollar exports turn deeply negative in the face “lower for longer” crude). Previously, we suggested that outflows could eventually reach $1.1 trillion. That figure was derived from a look at BofAML’s assessment of the size of the RMB carry trade, which is now unwinding.
Needless to say, rampant speculation that China is targeting a much larger devaluation than that implied by the August 11 “one and done” reset only serves to put more pressure on RMB, necessitating still more reserve drawdowns. Of course each round of intervention sucks liquidity out of the system which means Beijing must offset the tightening with RRR cuts and liquidity injections. But the very act of cutting rates and injecting cash is perceived by the market as easing, which puts more pressure on the yuan and the vicious, self-feeding loop is perpetuated.
On Monday, we get a fresh take on all of the above courtesy of Barclays who says that before it’s all said and done, China’s FX reserves could take a hit on the order of $1.2 trillion.
First, Barclays endeavors to explain when the adjustment will be sufficient for things to balance out or, alternatively, what will dictate the dynamics should the PBoC not allow for a deep enough adjustment:
An accurate picture of the scale of capital outflows along with new growth trend is crucial to understanding the extent of CNY depreciation needed and/or the sustainability of the market interventions/controls. Indeed, if policy makers are serious about having a marketdetermined exchange rate regime, the size of the real exchange rate adjustment will be enough at a point when capital outflows are largely financed by current account inflows or stable components of the capital account (FDI and portfolio outflows). On the flip side, if policy makers take a step back from the recent moves towards flexibility, increase their market interventions and implement controls then the scale of capital outflows and the new growth trend will determine the sustainability of such measures.
China’s slowdown coupled with the country’s economic transition to a consumption and services led model has decreased the extent to which outflows can be covered by current account surpluses:
Financing for capital outflows had been relatively straightforward when China was running very large current account surpluses. CA transactions fell below 8% in mid 2011 and have stayed low (around 5% of GDP including trade mis-invoicing) despite the increase in capital outflows. Weak global demand and competitiveness pressures as well as a push to rebalance growth away from exports to consumption have eroded the current account surplus in recent years.
And then there’s the infamous RMB carry trade, discussed in these pages on countless occasions:
China was able to offset capital outflows by increased borrowing from abroad, with total external debt standing at around USD1trn from different sources. We believe this borrowing captures a portion of the China carry trade – borrowing in USDs short term to fund RMB assets by onshore borrowers (corporates, banks and non bank financial entities). This increased borrowing was large enough such that China was able to not only compensate for outflows but also to accumulate reserves during the period of 2011-2014. Both FDI inflows and portfolio flows are now smaller than international borrowings. Absent these inflows, China would have been running down reserves for the last few years. Most of this recent financing has come from the increase in cross border borrowing by the Chinese private sector. We estimate that these flows have soaked up close to 30% of capital outflows over the last 5 years from practically 0% in 2008. Additionally, that these flows are short term in nature, denominated mainly in USDs and channelled to financial services and real estate sectors, adds to worries about their sustainability. About 75% of the current stock of roughly USD1.4trn of cross-border borrowing by the Chinese private borrowers has a maturity of less than one year.
Finally, here’s the “downside scenario”:
According to our measures, non-FDI capital outflows are 8-10% of GDP and the financing that may be available through the current account is 5-6% (inclusive of the trade mis-invoicing). The gap between the two is about 3-4% of GDP. This is assuming that outflows don't further accelerate from current levels. Greater flexibility in the exchange rate will help reduce the China carry trade and increase the repayment of international borrowings. Short-term debt as a percentage of GDP is running higher than historical averages at 4% of GDP and may decline from the current 10% of GDP. This means an additional outflow of about 5% of GDP.
Net FDI and portfolio flows currently add up to 2.5% of GDP, but these may dry up or reverse in the event of a serious enough growth shock. Flat net FDI and a reversal of portfolio flows similar to what happened in 2007 implies an outflow of 2% of GDP.
The above numbers suggest that in such a downside scenario there could be pressure on the central bank to provide about 10-12% of GDP in reserves to the market to offset outflows as well as hedging demand (which could be met by intervening in forward markets). This is roughly USD1.0-1.2trn – that would be about 30% of its current reserve portfolio.
And the puncline is this: "There would be a liquidity tightening onshore as these reserves are sold ... which implies the central bank needs to provide a 500bp cut in the RRR to keep liquidity conditions."
This is nothing new and indeed we've discussed it exhaustively, but it's worth reiterating why it's so important. Clearly, a 500 bps cut to a policy rate amounts to massive easing. Of course massive easing is usually associated with a weaker currency. In short, China's efforts to offset the devaluation pressure on the yuan necessitate outsized policy rate cuts that only serve to... exert more pressure on the currency.
As we've noted previously, if China ends up liquidating $1.2 trillion in reserves, that would (in a vacuum) offset more than 60% of QE3 and, based on the extant literature, put somewhere on the order of 200 bps of upward pressure on 10Y yields.
There are obviously any number of mitigating factors here, not the least of which is that it now appears the Fed is destined to trigger flights to safety no matter what it does, which could mean that USTs catch a bid from investors fleeing the sheer lunacy of central bankers but then again, when dovish leans by central bankers no longer boost risk assets we have a very serious problem, which means that in the end, if the market is banking on jittery investors' collective safe haven bid to fill the void left by China's UST liquidation, then it is effectively saying that the only thing that can save the world from China's massive reverse QE is the complete loss of central banker credibility.
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Yes it is called GOLD
I find it incredible that China can sustain outflows of $100 billion a month.
What other country has the muscle to take that kind of assault? Nobody.
http://news.yahoo.com/thai-model-slams-chinese-tourists-in-unbelievable-...
Well, at least she's lucky they didn't pee on her leg.
China's End-Game?
I have a theory/question I'd like to submit to ZH readers for analysis/feedback: What if China's long term strategy is to develop a self-sustaining consumer/service based economy that could operate independently of the rest of the world's economies, raw materials, energy, manufactured goods, and - most importantly - credit/banking systems? I guess what I'm asking is; could the Chinese now or a few years into the future, throw up a huge wall (no pun) and have a self contained 1st world economy that produces and consumes everything they need and regardless of what the rest of the world does? I know that they are far from energy independent, but could their provocative moves in contested energy rich waters and their military build up (Emphasizing "Area Denial") be designed to secure the energy resources necessary for a independent/closed economy? Could energy independence be the last step for world economic independence? Am I missing anything else that they would still be dependent on from the outside world?
The staggering pace that China has modernized it's military and economy through technology transfers, manufacturing development, and infrastructure construction has largely been possible because of easy credit and consumption for their manufactured goods from the West. If the Chinese could become truly independent of the West, what is to stop them from saying to the world, "All foreign debt is null and void. Go ahead and sanction us till you're blue in the face - We don't need your shit and don't need you to buy our shit. …and if your bankster masters want to start a war over our default, we have plenty of nukes and an adequate military to defend our interests thanks to years of espionage and technology transfers from short sighted western corporations."? Could this be China's end-game?
You mean like this?
http://www.cornellcurrent.com/2014/11/12/chinas-shift-to-a-consumption-d...
http://www.nytimes.com/2014/01/21/business/international/for-china-a-shi...
It's been noticed by economists worldwide. Cause it's the logical way for China. It does takes time. And IF you got many citizens? You got your raw materials correctly. Consumer based economy needs people as consumers.
As for dollar related? Why do you think China dumps dollar & purchasing gold?
Many ridicule China now. You'll see a decades from now, the turn over of China from export oriented, to consumerism based. China succeeding in turning their country to industrialized system. Still have doubt it can't changed course to consumer based economy?
This is an example, of changing to domestic consumers.
http://realmoney.thestreet.com/articles/09/09/2015/china-promises-boost-...
See the result of building roads (in 3-rd world country), when there aren't any before. See how farmer/ranchers start to trades much more when there's roads connecting isolated villages. I know. My government right now are doing the same (which i support it wholeheartly).
This country ruled by 1-party system. No fighting between GOP & Democrats like that Kardhasian Ass country across the pacific..
China needs to dump that crap asap.
It makes so much sense to throw 30% of your reserves in to protect an artificial bubble (that you helped create) in an asset class that make little difference to your economy.
How much does the U.S. have in its reserves? HaHaHaHaHa
Irrelevant as everyone has a printer/computer. What part of global Weimar don't you understand? LOL!!!
There is no way of really determining the impact of China's currency moves on the high end U.S. housing market. If China manages to control a sizable peercentage - 50% - of Chinese flight capital intended for purchae of American high rise co-op and condo propertes, the demand for overpriced real estate in the USA should plummet. As well, those developers who have depended on Chinese EB5 investors will take a hit. The end result could be all those "for sale" signs for expensive apartments will be replaced by "for rent" signs as the pool of buyers dwindles down.
Let China sell all their treasuries, fine by me. Let them stew in their own centrally-planned shit soup. We have enough to deal with.
Get long sharecropping and guillotines, beat the rush!
zerohedge sounds like CNBC when it posts this type of crap.
It took the transfer of nearly all the world's consumption based manufacturing to China to turn China into what it is today. Having a country of near limitless labor supply to produce goods for a few hundred million consumers around the globe, with the majority being the USA.
Where are the goods going to come from to supply a consumption and service based economy in China, Africa? Will we get Chinese complaining about cheap African shit?
It takes trillions of dollars in deficit spending on social programs to keep the consumption model alive in the US and 90% of what you see is really an illusion kept alive by the stock market. There simply isn't enough spare production elsewhere if manufacturing leaves China, which it is in droves.
The Chinese miracle was created by transferring trillions of dollars to China in exchange for allowing US publicly traded entities to expand margins. If that ends, so does Chinese growth.
The only future is a global depression. The bankers have made certain of that when they broke the only model of economic activity that worked.
I live surrounded by abandoned factory buildings, many with abandoned machinery still inside, and by men and women age 50+, skilled workers, technicians, retired engineers, who remember how it was and dream of going back into them, retooling them, reinventing them and starting them up again. The young folk will be a problem; most of them don't even know what a good job looks like, much less how to do a good job. But they'll learn, we can still teach them, and they too are dreamers and schemers. They too are hungry.
What stops us is of course capital, lack of markets and lack of purchasing power. We buy cheap shit at WalMart - what choice do we really have with our incomes? - and we can't produce to compete. But when that global conveyor belt powered by greed and misery shuts down, when in desperation local governments - or even a Federal government miraculously retaken and controlled by the people - turn to alternative systems of exchange and finance, we're ready and hungry to give it a go.
The danger right now is that many in despair are starting to turn to the easy answers, blaming China for our disastrous state of affairs, blaming the Mexicans, the "illegals", anybody but the billionaires and banksters who engineered this fiasco. Rebuilding our country is going to take all of us, incuding the top 1% (minus the top .01% or .1% who can go on off to their escape homes in New Zealand) and the bottom 1%, working together. The profiteers who don't care what becomes of us will push every button, every kind of division and chaos they can, to keep us divided and helpless.
It has begun with the throw away attitude society.
That was maybe in the 70th in the US, I dont know.But long before China.
Since then this kind of thinking has shitted everything.
When there is no demand for high, longlasting quality then there will no supply in the end.
China is only the endpoint of this evolution.
There is a choice. You don't have to buy cheap Chinese shit. There is a saddler / leather shop near where I live. I got sick of buying a 15 to 25 dollar belt only to watch it fall apart in a few short months - sometimes weeks. All the belts I bought were either made in China, Ecuador, Malaysia, Vietnam, etc.
I went into this local shop and asked them if they could make me a belt. They said, "Sure, what kind?" Long story short, I chose the leather height and width, the buckle style, and they measured my waist. A week later I went back and picked up two belts (one black, the other brown) and interchangeable buckle. I switch the buckle back and fourth between the two belts (No, it's not one of those huge "cow-boy" type buckles - simple pin and roller bar deal).
That was three years ago, and my quality, hand made, real leather belts are still going strong today. How much did I pay: $66 I know many would look at me like I had gone "full retard" paying 66 dollars for two belts and one buckle. That's fine. For me, I'd rather pay a little more upfront for something quality, than buy something cheap and not knowing how long it would hold up.
Those factories didn't just vanish over night. It took years and millions of americans making the choice to save a few bucks now and flush the greatest manufacturing economy down the drain.
Don't blame the Chinese
Don't blame the greedy banksters, CEOs, etc.
BLAME YOURSELF
You had a choice America…this is what you chose.
The easy money policy along with artificial support of markets has created such an over-capacity in everything industrial (mining through shipping) that it will be a long time before there is a market damand sufficient to support new factory openings in the USA.
Who would have thought we'd see the day when a mere trillion dollars of mismanaged money could crush the world?
Don't you dare bail me in,bitchez.
Really. Don't see it? China de-dolarisation continues. Even if all foreign investments taken out? The expertise stays with China. It just turn it to its domestic consumers. Deleveraging? sure. Every over-capacity cause by excessive liquidity? must be deleverage first.
You only see this year trends.
I looking at them as (at least for a decade) changing focus from export oriented to consumption based economic.
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Let see china CIPS (SWIFT replacement) system ready this year. AIIB already runs. Russia/China rating agency prepared. Bilaterals local currency already massive. And yuan settlements? Here's the signs.
http://www.chinadailyasia.com/business/2015-03/12/content_15237936.html
(3/4th of a T$ equivalent yuan's settlements in 2014. I wonder how much this 2015 year would be??)
China is the one that DO. Not just TALK & FIGHTS over that talks. Even if you makes MISTAKES? At least you TRY to DO it. If you try to DO a 1000 times? At least you might get 1 (ONE) rights. And that's BETTER than doing NOTHING..