Tuesday, September 8, 2015

De-sensationalizing China's reserve losses

Here's how the NY Times today described what is going on with China's currency and foreign exchange reserves (emphasis mine):

HONG KONG — China is burning through its huge stockpile of foreign exchange reserves at the fastest pace yet as it seeks to prop up its currency and stem a rising tide of money flowing out of the country. 
Even after a record monthly decrease of nearly $100 billion, China still has the world’s biggest cache of foreign reserves, standing at $3.56 trillion at the end of last month, government data showed on Monday. 
The total has declined steadily from a peak of nearly $4 trillion in June of last year, as slowing economic growth caused investors to move money out of the country in search of better returns elsewhere. As a result, the Chinese central bank has had to sell huge amounts from its foreign reserves to maintain the strength of the nation’s currency, the renminbi.

In reality, the news out of China is not nearly as breathless.

In August, China sold about $100 billion of its foreign exchange reserves, for a decline of 2.6%. China's reserves have now fallen by 11% from their all-time high just over a year ago. Since its all-time high early last year, the yuan has declined by about 5% vis a vis the dollar. The Chinese central bank is not seeking to "prop up" its currency; it is responding to what to date have been modest outflows of capital by lowering the yuan's peg to the dollar. 

This marks a reversal of the yuan's trend over the previous 20 years, to be sure, but it does not represent a radical policy departure. China has managed the yuan's currency peg on a consistent basis over the years, allowing the currency to appreciate as capital flowed into the country, and now, allowing the currency to depreciate as capital leaves the country. What this means is that China is no longer the powerhouse that it used to be and therefore its currency is not as attractive as it once was. The new reality in China is one of adjustment to slower growth. If capital continues to leave the country—as seems likely—the central bank will continue to shrink the Chinese monetary base and continue to adjust the yuan's peg downward until a new equilibrium is reached. This is all straight out of monetary policy textbooks. 

Even after its recent declines, the yuan's value is still almost double, in real terms, what it was against a large basket of currencies 20 years ago (the chart above reflects data through July '15). Remember how China's critics for many years have charged that China was artificially depressing the value of its currency in order to boost its exports? Now those same critics say the sky is falling because China is trying to keep its currency from weakening. In reality, the yuan has been and continues to be one of the world's strongest currencies, and China's foreign exchange reserves still tower over those of the world's developed economies.


Hans said...


marcusbalbus said...

go long the yuan grannis. lets see how that plays out

steve said...

Off point but Stiglitz thinks it's a "no-brainer" for fed to hold on rates. Besides the fact that I HATE stupid phrases like that, this is proof positive that the Fed certainly should raise rates and hopefully will. If not now, when?


Scott Grannis said...

I don't usually make bets on currencies, but if I had to, I would probably short the yuan, as I implied in the post.

I rarely if ever agree with Stieglitz, and I'm happy we don't agree now.

marcusbalbus said...

that has to be one of the strangest or deeply complex layered post that leads to "i mean short the yuan".

Benjamin Cole said...

Why the Chinese ever peg the yuan to the US dollar I do not know. It has been a mistake. It has resulted in a tight money policy in China, a nation that needs 7-8% real GDP growth every year.

Should the Fed raise rates? Larry Summers is now blogging and I heartily recommend his post of September 9th to all.

I would go further than Summers, and say that not only should the Fed not raise rates, it should ponder going back to some steady state of QE as is the Bank of Japan.