'What Does The Fed Do Here?' Is A Question That Misses The Point
Authored by Jeffrey Snider via RealClearMarkets.com,
It was a riotous summer, the heat scorching the world from one end to the other. Many remember it for all the wrong symptoms, beginning with the so-called taper tantrum. The year 2013 was many things, and there were several consequential tantrums in the middle of it, it’s just that they had nearly nothing to do with the Fed’s taper.
For one thing, the sell-off in USTs and other global fixed income which began in May reversed course suspiciously quickly. According to some markets, eurodollar futures, in particular, it was over by early September. The yield curve would top out (steepest point) by November. Nominal rates peaked at year’s end.
From the very first day in 2014, the dollar began ringing China’s yuan bell. CNY carried with it a nearly mythical place in Western ideology, sparked by an unhealthy affection for those presumed behind the currency’s unrelenting “strength.” The grass always greener to our own wannabes, the skies sunnier to them under the despotic technocracy the Chinese Communists claim to have perfected.
But 2013 wasn’t all that great or even good in Central Planning Paradise. On the contrary, from the earlier stages, the People’s Bank of China found itself alone fighting severe bouts of illiquidity the vaunted technocracy could not seem to eliminate no matter how many times it scolded market participants (moral suasion is equally ineffective there as here).
Where we had our taper tantrum, this was also the Summer of SHIBOR.
To try and address these persistent cash shortfalls, China’s central bank hastily arranged something called the Standing Lending Facility, or SLF. This was no overly complicated structure, as can be typical of Chinese official practice, rather the SLF akin to the Federal Reserve’s Discount Window (Primary Credit); the same the Fed had operated (if hardly used) from its very origin.
How could a major central bank from the world’s second largest economy and financial system not have something like the Discount Window until relatively recently?
Easy. Up until around 2012, it just wasn’t necessary. Cash flowed into China from the outside by the billions, then tens of billions, reaching hundreds of billions. None of it real cash, of course, there rarely is any, rather virtual ledger balances kept track of by the world’s real monetary system, the ubiquitous eurodollar banks.
What internal monetary mechanics the PBOC had practiced targeted the currency and prospective inflation, essentially trying to manage way, way too much money. In the grand scheme of everything, a far better problem to have, one which is especially necessary with China’s economy transforming into what everyone thought would be an unstoppable powerhouse for decades more to come.
Even 2008’s Global Monetary (not financial) Crisis didn’t appear to derail the country’s economic and financial prospects owing largely to the eurodollar system’s continued preference for it over everyone else; while the developed world would struggle in its “new normal” post-crisis, everyone bought into – literally – King Beijing.
The dollars kept coming.
Then they stopped coming.
This was right around 2011 when what was called a European Sovereign Debt Crisis (another misapplied name) squashed that little certainty surrounding Asia dependent upon King Beijing. The firehose of eurodollars once blasting over the border quickly became a trickle.
Without so much foreign “capital”, most of which got turned over to the PBOC in its inflation/CNY/management paradigm in exchange for RMB reserves, China’s big financials found themselves in 2012 and especially 2013 for want of RMB liquidity. Suddenly, a Discount Window equivalent which had been a complete afterthought before got hastily arranged.
And still the Summer of SHIBOR happened anyway. As the main money market rate inside China, the chaos calculated from within its panel (entirely-too-reminiscent of LIBOR’s 2007-08 experience) was a total shock as everything once assumed permanent was upended in a matter of months.
The taper tantrum’s early end was as much about this Chinese reversal as anything else, markets becoming ultra-worried seeing potential red from the land of the Reds. Treasuries selling off in 2013 had been a good sign, a signal that the market was agreeing with Ben Bernanke’s take on the economy, that it might have been recovering in a way which would lead policymakers, anyway, to rethink their policy positions.
Once the monetary disaster which only began that summer started to truly drive the point home, suddenly more and more began to realize how actually no one was going to escape what started in August 2007. Not even China.
Even the Dallas branch of the Federal Reserve, reviewing these events in 2021, correctly surmised some of the basics:
“Most emerging-market countries can’t borrow abroad in their own currency. When a country runs a trade deficit, it needs to borrow in U.S. dollars to cover that deficit. Over time, this leads to a stock of foreign currency-denominated debt. The country needs a steady stream of dollar financing to finance current deficits and to service and roll over any dollar-denominated debt.”
True, and this was a major issue for many countries (like Brazil) who found themselves caught up in everything. Dollar providers out in the eurodollar shadows who become risk averse tend not to provide enough dollars where risks were once incorrectly believed small.
However, setting aside risks, China didn't run a trade deficit then – and doesn't now.
On the contrary, the Chinese have benefited from decades of a massive, seemingly ever-growing trade surplus. For the calendar year 2013, that excess reached $259 billion (according to China’s General Administration of Customs). Figure another $30 billion or so for net investment flows, more income receipts from the rest of the world than interest payments and such out to it, China really should have been awash in dollar cash feeding into RMB reserves at the PBOC such that no SLF would have been necessary. A monetary inflow of organic economics regardless of eurodollar risk perceptions.
So, where did all that money go?
To those at the Dallas Fed, or anywhere in the Fed, it was “capital outflows” of the standard textbook sort.
“Federal Reserve tightening, or even the expectation of tightening, complicates this dollar financing, as investors reallocate their holdings to now higher-yielding U.S. assets. This leads to currency depreciation in the debtor countries and rising instability due to an increase in the real (inflation-adjusted) value of foreign currency-denominated debt.”
While the (euro)dollars do disappear from these places, it sure as hell isn’t because investors can earn a few extra bps, maybe even a few percentage points on US Treasury debt. This is the problem with central bankers as Economists, they think of everything in terms of an academic worldview populated by spreadsheets.
Money hadn’t been seeking out opportunity in China because investors believed they get a small spread over USTs, eurodollars went there because of the Chinese trade surplus (and BoP) along with risk-takers believing they were going to get insanely rich off China’s massive, forever-juicy and dependably-friendly economic structure.
They’d suddenly pull up stakes in 2013 because the Fed in 2015 might get off a few 25 bps rate hikes? Please.
All these imbalances would only get worse – so much worse – in 2014. The PBOC’s SLF proved as ineffective as the Fed’s, well, everything. CNY completely reversed course and plummeted. Trying to stabilize the currency, at least, China’s central bank found itself selling off reserves and by doing so supplying the dangerously dry funding market with “dollars” that market wouldn’t otherwise supply itself.
The dates don’t line up, either. QEs 3 and 4 were ongoing all throughout this period. Bernanke first hinted at tapering in May 2013. It wasn’t actually carried out until December, and then those weren’t terminated until October 2014. By then, China – along with basically every other emerging market country - was already toast.
The previous paradigm had completely reversed; dollars flowed out, depriving both the PBOC (and SAFE) and commercial banks of foreign exchange, leaving each with fewer organic additions in RMB. And the irresistible rise of CNY screeched to a halt, then abruptly (right from the beginning of 2014) reversed course.
Damage ended up being astronomical, in money as well as economic terms. As to the former, Chinese authorities ended up burning through nearly $1 trillion in reserves by the middle of 2016.
Where did all that “cash” go?
It vanished up in the smoke of a world-shattering depressionary deflation.
This wasn’t the work of US authorities instituting an ultra-cautious end to QEs 3 and 4 (yes, there had been four up to 2014) and then maybe, possibly some rate hikes down the line in 2015 enticing the safest investors to bring some cash home from China. The incongruity really should have launched an aggressive search for real answers, not copy and paste from the outdated textbooks as Dallas would offer even so many years afterward.
Facing the end of 2022, China’s numbers are now “somehow” even bigger – and not in a good way, rather 2013-style. Whereas the country started on the plus side with a quarter trillion in merchandise surplus dollars back then, this year authorities put it at over $800 billion, and that’s with another month left to go to add more to it!
Yet, despite that plus another $70 to maybe $100 billion net investment inflows, China’s SAFE shows $132.7 billion fewer total forex reserves. The PBOC displays none of it; in either direction.
Where most of that $800 billion really should have made its way onto the central bank’s balance sheet, instead Chinese authorities have to be trolling us all. Forex balances for the insanely complicated monetary, financial, and economic system there have moved in such a narrow range (for several years, now) it has to be a joke, doesn’t it?
No. This is deadly serious stuff which remains without answer, or even any serious appreciation let alone useful discussion.
Another trillion “dollar” hole left in China’s money isn’t because the safety of USTs yields a few percent more this year than in 2013 (look it up; yields aren’t actually all that higher than they were in the second half of that year).
The issue only begins with this fatal conceit:
“…I continue to believe that monetary policy at its current level is accommodative and that, if this current stance is sustained, the economy will experience faster inflation in the medium term.”
Those words were muttered by Charles Plosser, the Philadelphia Fed’s President on September 16, 2008 – the day after Lehman Brothers.
Nothing has changed since that day, except how acute these intermittent global dollar shortages have gotten to be along the way.
Sometimes more manageable than others. SHIBOR Summer turned out to be simply the opening round of one that would prove unmanageable.
All the while those at the Fed tell us – and the Chinese – monetary policy is or has been highly accommodative.
As the dawn of 2023 approaches, it does so beginning with what by any rational account appears to be another trillion dollar hole in global finances.
I write “another” because China is hardly the only one to experience such a deficit in 2022, cumulatively those adding up to their own trillion. Give or take a few hundred billion.
What does the Fed do here? No. What does the Fed have to do with any of it.
Do have a Happy New Year, as best as you might.