Raising The Stakes, But Not The Level Of Understanding
Alhambra Investment Partners, LLC | Feb 08, 2017 02:00AM ET
China’s Foreign Exchange Agency reported a $12 billion drawdown in that country’s foreign “reserves” holdings during January 2017. That was considerably less than the past three months, where all three saw more than $40 billion pulled out, nearly $70 billion in just November. These results are not in any way surprising, and are actually quite consistent with observed behavior during the past few years.
Though many have chosen to emphasize the level of “reserves”, with January’s small decline pushing the published total under $3 trillion for the first time in almost 6 years, the pattern of the monthly variations is and has been what is truly significant and relevant. Focusing here instead, allows us to further calibrate to what it is the PBOC has been doing all this time and more importantly why.
First and foremost is the fact it is no mere coincidence that China has experienced “outflows” during the “rising dollar” period. Thus, if we dispense with the euphemisms, Chinese official channels have tried, and failed, to fill in (“outflows”) the growing funding gap that country’s banks have experienced during this outbreak of a “dollar” shortage (“rising dollar”). The manner in which they have done so is described by another incomplete phrase, “selling U.S. Treasuries”. In the case of overall foreign reserves, the mix is not completely of UST’s but mostly of them.
The wholesale nature of the “dollar” system, however, is often incompatible with traditional accounting, and even more so in this setting. This is true for all counterparties engaged in these sorts of activities (meaning everyone), but more so the Chinese who report even less in whatever accounting framework than practically anyone else. We can reasonably assume that the PBOC operating directly or through Chinese banks has been engaged in derivative activities that alter the variations in the official accounting statistics like total foreign “reserves.”
Get The News You Want
These hidden operations are revealed for their very close relationship with the Chinese currency. In very general terms, using again more neutral terminology, the lightest months in terms of outflows are those where it has been very likely the PBOC’s efforts have been the greatest. This may seem counterintuitive, but the smaller pace of the reduction in official reserves in January 2017 is actually consistent with what is observed in the exchange rate versus the dollar, not because the PBOC is selling fewer UST’s but because they are providing “dollars” instead in other formats – taking the pressure off of UST’s.
Because, however, these other formats, including repos, swaps, and forwards, are time sensitive what happens is almost like writing a check; the level of reserves stays more constant when forward operations are heaviest until that check is “cashed” several months ahead (three, usually) in the form of heavier selling UST’s all over again.
This also suggests the nature of that 3-month interval, meaning that given what the PBOC does is merely a maturity transformation of its “dollar” problem, it only adds to the “bill”, so to speak, at that future date and intensifying both the “selling of UST’s” as well as the falling CNY rate that happens during those escalations. If you think about it in terms of buying time, the heavy outflow months as well as the lower CNY rate that accompanies them three months forward is the visible price of that purchase.
Therefore, what we see in the foreign “reserve” data is not the difference between inflows and outflows, or as lately big outflows and lesser outflows, but rather the variation in how the PBOC chooses to address the overall, undisturbed “dollar” shortage; moving from more traditional to less conventional and back again; from almost totally hidden to more easily observed (but still partially in the shadows).
The relationship is not a perfect one nor is it a one to one correlation (as you can see for the “devaluation”, to use yet another euphemism, in July 2016), and we should never expect such a clear picture. There is a significant amount not covered by any of these figures, a lot if not all that we will never be privy to. As I wrote above, it is about calibration and putting together a coherent and consistent explanation for the state of affairs in China as well as beyond its borders rather than groping for answers in the dark of traditional “analysis” (another euphemism).
Such as :
China’s foreign exchange reserves unexpectedly fell below the closely watched $3 trillion level in January for the first time in nearly six years, though tighter regulatory controls appeared to [sic] making some progress in slowing capital outflows…
Some analysts fear a heavy and sustained drain on reserves could prompt Beijing to devalue the yuan as it did in 2015, which could throw global financial markets into turmoil and stoke political tensions with the new U.S. administration. [emphasis added]
It’s not like the stakes are low and getting lower for actually understanding what has been going on in the monetary world.
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.