It's Not Just China, "The Whole Damn System Is Untenable"

Submitted by Tyler Durden on 01/13/2016 13:50 -0500

Submitted by Jeffrey Snider via Alhambra Investment Partners,

If the PBOC was desperate last week, the catalog of words describing their likely stance this week is unbelievably short (pun intended). In the handbook of central bank operations, when conditions truly spiral out of control the first entry in that chapter says to blame speculators. Primary among them, subchapter one in the handbook, are the short sellers. If you think back to 2008, even the supposedly steady and omniscient Federal Reserve encouraged the SEC to ban short selling on bank stocks (first naked that July; then outright on September 19). As if it needs to be pointed out, it doesn’t work.

What short selling bans amount to are acts of proclaimed exhaustion; the central bank or central financial authority has no other options left and short sellers make a good and public target. Increasingly, it seems the PBOC in calling for increased “flexibility” (read: despair) the past few weeks (subscription required) has more and more focused on those speculators supposedly short selling yuan. Because of China’s dual market for currency, CNY and CNH (offshore), any distance between them supposedly opens arbitrage opportunities which can only further destabilize an already precarious position. Thus, by targeting speculation of that kind the PBOC claims to be working back toward good order.

So the behavior of the “dollar” is much like a short squeeze, and now the PBOC has used its state run banks to enact a short squeeze in yuan – fighting a short squeeze with a short squeeze. How could it possibly fail?

The arb between onshore and offshore RMB has the effect of moving “dollar” transactions to Hong Kong and away from onshore China; a “speculator” might “buy” CNH in Hong Kong and then “sell” in CNY in Shanghai, all using “dollars” as the funding mechanism. It displaces dollar activity and volume that is obviously needed and necessary onshore where the PBOC clearly believes it has legitimate interests. In other words, this is not the center of China’s “dollar” problem so much as it makes it that much more difficult and unsteady.

To be more specific, these damned “speculators” are believed not so much “buying” CNH and “selling” CNY but rather “borrowing” CNH and “lending” CNY. The jargon and technicalities get confusing because intent matters in these affairs more so than the actual arrangement of transactions. By tasking state banks to “buy up” CNH, that left little liquidity with which speculators might “borrow” and short it. The results:

ABOOK Jan 2016 Desperate China CNH

Overnight HIBOR (CNH) hit a ridiculous 66.815%, while one-week HIBOR spiked to 33.791%! Even the 3-month maturity blasted to a record, jumping to 10.42%.

ABOOK Jan 2016 Desperate China CNH 3M

If you think the problem is shorts, in this case CNH speculative shorts, then 66% borrowing rates should work – for a time. If, however, you have some appreciation for the Asian flu and Thailand’s role in it, there is an eerie rerun taking place except in China rather than Thailand. As I wrote two and a half years ago (and then updated last week) in trying to argue why Brazil would almost certainly follow Thailand (which they did):

In terms of the proximate currency problem in Thailand 1997, the Thai central bank did what the monetary textbook says to do. Unfortunately, economics and economists rarely understand finance, speculators in particular. To defend the baht, the Bank of Thailand sold dollars into the spot market and then engaged derivatives trades, dollar swaps, to protect their reserve stash…

But swaps, particularly when engaged with the “market” instead of with another coordinating central bank, actually fuel the currency’s demise. Because of the leverage obtainable in currency speculation, the only real means to reduce speculative selling pressure is to make the currency more expensive to short (since it must be borrowed, reduce the availability). Engaging in swaps, which amount to forward selling of dollar reserves, reduce the pressure on interest rates in the short-term funding markets. It’s like sterilizing the impact of selling dollars in the spot market – the central bank selling dollars buys the local currency, making it less available and thus theoretically driving up the cost to borrow it. If you pair the spot intervention with a swap/forward, you’ve given speculators a huge alternative access point to borrow/short your currency.

We know that PBOC has been taking swaps and forwards as a primary measure for intended CNY stability; they confirmed as much months ago, though they needn’t have done so given the obvious trajectory in the currency exchange rate (3-month intervals are insanely prominent). The actions this week in CNH money markets confirms the second part, as the central bank now goes about making CNH (and CNY by indirect proxy) almost impossible to short.

If those swaps and forwards were intentioned toward stopping prior “devaluation”, or at least reducing it, that meant the PBOC was essentially selling dollars (in derivative form) immediately, or putting the PBOC short the dollar/long CNY. At maturity, the PBOC then has to reverse (or roll, which isn’t a clear cut option) meaning that it will have to “buy” dollars by “selling” CNY – exactly the opposite position as it is staking out this week. The actual mechanics can and will be much more complex and intricate, but in general terms that is what takes place. Therefore you can see how these efforts in many ways undermine each other; the PBOC on the one hand this week is making it more difficult to borrow yuan while at the same time past derivative arrangements are coming due with which the PBOC is providing yuan to the “speculative market.”

The only hope is that the geographical distinction offshore vs. onshore becomes something of a positive rearrangement as the PBOC’s derivatives have it supplying yuan in CNY. The fact that such fragmentation has already arisen suggests the problem with all of this to begin with (below).

ABOOK Jan 2016 Desperate China CNY2

Typically, the timing of these legs are lagged so that there isn’t a direct cancelation of one to the other. In Thailand, for example, the efforts appeared to have worked but only for a short while until the forces of repression simply returned with a vengeance (in Brazil, Banco do Brasil bought more time that Thailand managed but ultimately it didn’t matter either). That means the PBOC’s attempts exhibit undoubtedly the same frailty; it is only to “buy time” with the hope that the primary problem of repression somehow just goes away. In the context of speculators, that would mean that the PBOC, as Thailand and Brazil, is trying for an ultimate display of monetary power so that they “get the message” and just take their dastardly schemes someplace elsewhere. Unfortunately, speculators never seem to cooperate in that respect because speculation is never really the problem.

ABOOK Jan 2016 Desperate China CNY

In attacking the speculative aspects of these currency repressions, central banks never answer the question that should be addressed from the very start: why are speculators “attacking” in the first place? Why would the Thai baht in 1997, Brazilian real in 2013 and Chinese CNY (or CNH) in 2015 seem a good place to make a currency killing? Speculation is but one mechanism by which imbalance is brought back to a steady state. It is a violent, messy and disorderly method, but cuttingly effective which is why short speculation makes for such a good, public target. Nobody likes disorder but the orthodox economics textbook has made it exponentially more undesirable by treating market forces as the enemy when in fact it is markets that, when allowed, produce needed efficiency in the long run. Central banks trade short term outbreaks of calm for long run continued problems of inefficiency and imbalance. Market forces, including speculation, is trying to trade short run disorder and turmoil, sometimes very nasty, in order to find a more suitable long run balance.

China is untenable in its current financial position. That is the primary problem, and so long as it remains so whatever the PBOC does will have but a fleeting impact. In more immediate terms, that is being recognized by the “dollar” run which continues to savage not just China but South America (more than just Brazil), Africa, Asia (more than China) and you might even argue Canada and Mexico. From that, we see that it isn’t China that is the problem with the “dollar”, it is the whole damn system.

I think we are well past the point of no return where ever major adjustments can be undertaken in order to preserve that past functionality. Volatility itself will ensure that, because once volatility becomes significant the world’s mathematical models start flashing uncontrollable warnings (for resource providers, the money dealers, the warning is to get out or get out even quicker; for speculators, the warning is to attack the volatility as a huge opportunity) which then become self-reinforcing. Imbalance no longer able to be maintained becomes a paradigm shift or reset. Unfortunately, 2008 was an attempted reset which is increasingly revealed (past 2011) as an aborted one.

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Wed, 01/13/2016 - 13:54 | 7041333 Tarzan

Jamie Dimon, "I think IT'S ALL CHINA"

Wed, 01/13/2016 - 13:55 | 7041348 Squid Viscous

blah blah blah, time to front-run the 3pm NY fed induced jam job.

Wed, 01/13/2016 - 14:12 | 7041430 Jack Burton

Did the same thing in UK yesterday up 1% on a total economic meltdown. UK plunge protection

Wed, 01/13/2016 - 14:14 | 7041441 Bastiat

Good luck with that . . .

Wed, 01/13/2016 - 14:19 | 7041461 HardAssets

How do you say "Duh, no kidding" in Mandarin Chinese ?

Wed, 01/13/2016 - 14:04 | 7041388 F0ster

Trillions in excess reserves nicely positioned to buy up the impending Chinese fire sale.

Wed, 01/13/2016 - 14:09 | 7041417 conraddobler

True volatility blows up the insurance models as the risk premium for protection blows out then hedges blow up then you actually have to SELL to reduce risk.

It's wired to blow but for it to blow the price of hedging or just hedging in general has to blow first.

Wed, 01/13/2016 - 14:13 | 7041426 Dr. Engali

Yep, the whole system is coming apart as we speak. It's funny watching people on teevee pretend like nothing is happening.

Wed, 01/13/2016 - 14:12 | 7041428 buzzsaw99

let it burn

Wed, 01/13/2016 - 14:21 | 7041473 Sir SpeaksALot

all this casino stocks playing is fucking disgusting.

I certainly hope that after the "Change" we ban all corporations and there will be no stock markets.

Wed, 01/13/2016 - 14:21 | 7041475 asteroids

China is having their Lehman moment. Credit between banks freezes as one CEO doesn't trust the other CEO. Pass the popcorn.

Wed, 01/13/2016 - 14:44 | 7041615 claude

Time to end the pseudo capitalism and globalism and replace it with cooperation amongst neighbors

Wed, 01/13/2016 - 14:47 | 7041640 In.Sip.ient

Am I the only one who thinks theres

gonna be a big bang... sometime real

soon? 100% chance before Q3 starts???

Wed, 01/13/2016 - 15:02 | 7041783 bid the soldier...

Blah blah blah

blame speculators. Primary among them ..... are the short sellers. If you think back to 2008

Okay, dude, let's think back to 2008. And let's think about trading oil futures.

December 14, 2007 barrel of oil was $91.27

July 11, 2008 barrel of oil was $147

And, are you sitting down, Mr dirty Shorts?

December 23, 2008 oil was TA DA $30.28

Take your Jesus and Moses loves speculators and short sellers and get the f*^k out of here.

Wed, 01/13/2016 - 15:16 | 7041874 falak pema

The primary problem is : all those who are UNTENABLE are PART of the WS Reserve hegemony system.

If the digtial money system is systemic the PEGS just get blown away; in CHINA, in SAUD and then in YEN and EURO...

The Dominoes...

Its all part of the digital money web.

SO tell me the tea party drinkers...How will DONALD solve THIS ONE?

Wed, 01/13/2016 - 15:24 | 7041933 uhb

nice one. at least ONE tylor incarnation is still writing good stuff.

Wed, 01/13/2016 - 15:30 | 7041978 Libertati Aut A...

Understanding how much the markets are manipulated and coordinated with the media, there is no reason for this market not to have a capitulation fall to squeeze out the suckers, and then when the Fed holds a special news conference, rebound baby just like sep-oct.

Wed, 01/13/2016 - 15:53 | 7042122 Consuelo