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 China’s central bank said its reserves fell by $43 billion in July
to $3.65 trillion, in the first ever monthly report on the figure.
China’s foreign reserves, by far the largest in the world, have now
been falling for more than a year, setting in motion what looks to
be the long-term reversal of a trend in place since 1999.
Foreign reserves are falling because money is leaving China but its
central bank, at least thus far, wants to hold the value of the yuan
stable, in part because of plans to position it as a leading global
reserve currency.
“Against the backdrop of capital outflows, the People’s Bank of
China has shifted from accumulating reserves to prevent currency
strength to drawing down reserves to forestall weakness,” Alvin Tan
and Jason Daw, strategists at Societe Generale, wrote in a note to
clients.
In an open economy flows outward would cause the currency to fall,
but not in China, with its history of tight management of the value
of the yuan.
It is hard to overstate what a massive force the buildup of China’s
pile of foreign currency has been, driving its desire to buy up
dollar assets, notably Treasuries, and thereby helping to finance
all dollar-based borrowers everywhere.
This implies, in turn, that should the Chinese be turning into major
sellers of the dollar and Treasuries that, all else being equal,
credit, for everything from trade to investment to consumption, will
become more expensive.
All else rarely is equal and thus far, at least, the dollar remains
strong and interest rates low.
Reserves have fallen despite China exporting more than it imports,
not to mention income from overseas investments flowing in. While
foreign investors have cooled to Chinese securities, which recently
suffered falls after even larger gains, a sizable amount of the
money flowing out is likely Chinese-controlled money seeking either
better prospects for investment or better protections against the
possibility of confiscation.
This may be the irony of China’s Herculean efforts to support its
own stock market: it is motivated in part by a desire not to spook
investors but by doing things like going after short sellers it only
reinforces fears.
SHIFT IN ECONOMIC POWER
While exporters in China would dearly love for it to allow the yuan
to weaken, authorities are now preoccupied with efforts to convince
the International Monetary Fund to decide in November to include the
yuan in a basket of global reserve currencies it uses to calculate
Special Drawing Rights, an instrument it creates and is used in
central bank reserve management. A beggar-thy-neighbor depreciation
might not go over so well internationally, a fact which argues for
China holding the yuan steady and continuing to run down reserves.
Taking foreign exchange reserve flows and other movements out of
China together, China exported $126 billion of capital to the rest
of the world in July, a $1.5 trillion annual clip, according to an
estimate by research firm High Frequency Economics.
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“We continue to watch the projection of China’s economic might by
direct investments abroad. This is a massive change in the global
balance of economic power,” Carl Weinberg of High Frequency
Economics wrote in a note to clients.
Some of that capital is going to fund so-called Silk Roads projects,
like the recently announced $46 billion plan to create an economic
corridor linking China and Pakistan.
Other funds, privately controlled, are being used to buy real estate
in Sydney, New York or central London, or to make private
investments in companies and securities abroad.
It may simply be that, having built up a huge store of wealth, but
now facing an economy which is both slowing and making a fraught
transition from one centered on production and exports to
consumption, Chinese capital quite reasonably will want to
diversify.
This implies continued pressure on the yuan and reserves.
There is little question that China has both enough money and
resolve to continue its current support of the yuan. A falling
currency might exacerbate its market problems at home, and make it
less popular abroad.
Still, as dollars flow outward, it is likely that either Treasuries
will be sold or, at the very least, the proceeds from maturing bonds
not reinvested. The U.S. Treasury estimates that China, as of May,
holds a bit less than $1.3 trillion of Treasuries, by far the
largest official investor.
Later this year we may get China selling alongside the Federal
Reserve raising interest rates, both of which will act together to
tighten credit.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund. You can email him at
jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
(Editing by James Dalgleish)
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