All posts in category PBoC

The cost of the Sino-US FX deal: Surging money market rates (in Hong Kong)

This is from Financial Times’ FT Fast this morning:

A key lending rate between Hong Kong banks jumped to its highest level since February, potentially making it more expensive to short the renminbi.

The overnight CNH-Hong Kong Interbank Offer Rate (Hibor), a daily benchmark for offshore renminbi interbank lending, jumped to 5.446 per cent on Thursday – its highest level since February 19 – from 1.56767 per cent yesterday, write Peter Wells and Hudson Lockett.

Hong Kong banks do not rely on Hibor to anywhere near the same degree that global banks rely on Libor, the more famous US-dollar counterpart that is a crucial benchmark for loans that global lenders rely on for trillions of dollars of funding each day.

As such, the spike in CNH-Hibor has little practical impact on the banks themselves, but it has recently been viewed as more of a deterrent to speculators betting on CNH, the offshore renminbi.

On January 12, CNH-Hibor hit 66.815 per cent, the highest level since the benchmark was introduced in 2013, amid heavy speculation the People’s Bank of China, acting through state-owned banks, was soaking up liquidity to make the cost of shorting the renminbi more prohibitive as the currency came under pressure from speculators.

Ahead of this month’s G20 summit Commerzbank analyst Hao Zhou was among those predicting the PBoC would hold the line at Rmb6.7 against the dollar for a number of reasons, including a desire to facilitate special drawing rights (SDR) operations set to begin on October 1. However, he noted that “of course, politics tops the agenda again, especially as China is keen to show its ability to manage the whole economy and financial markets although the country still faces strong capital outflows.”

The central bank today weakened the currency’s midpoint fix for the first time since the end of G20, a move in line with analyst predictions that efforts to shore up the renminbi’s value would dissipate when the summit was over.

A spike in Hibor would track with a scenario in which the central bank either intervened itself or had mainland banks sop up liquidity on its behalf. It also has other options – as Commerzbank’s Zhou noted late last month: “We also expect that China’s central bank will allow the local banks to trade CNH in September, in order to narrow the CNY-CNH spread.”

This happens after China and the US over the weekend agreed to “refrain from competitive devaluations and not target exchange rates for competitive purposes”.

As my loyal readers know I am very critical about this deal (see my post on that topic here) as I believe that it is an attempt to quasi fix global exchange rates to avoid ‘currency war’ effectively limits the possibility for monetary easing – both in the US and China.

Ending China’s crawling devaluation will be bad news 

Since the Federal Reserve in December hiked the fed funds target rate the People Bank of China effective has tried to decouple Chinese monetary policy from US monetary policy by allowing a crawling devaluation of the Renminbi.

rmb-crawling-devaluation

This in my view has played a positive role in offsetting the negative impact of the Fed’s foolish attempt to tighten US monetary conditions.

However, the Sino-US ‘currency peace’ deal limits the PBoC’s possibility of continuing this policy and this is why HIBOR rates are now surging. This obviously is bad news for the Chinese economy – in fact it is bad news for the global economy and markets.

China does not need tighter monetary conditions. Chinese monetary conditions in my view is still quasi-deflationary and if the PBoC abandons its unannounced crawling devaluation policy it will cause a excessive tightening of Chinese monetary conditions, which could push back the Chinese economy towards recession.

It is too bad that policy makers from the ‘Global Monetary Superpowers’ believe that limiting currency flexibility is the right policy. Instead they should embrace floating exchange rates and instead focus on avoiding the biggest risk to the global economy – deflation.

 

 

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1 Comment
by Lars Christensen on September 8, 2016  •  Permalink
Posted in Currency war, Deflation, Devaluation, Federal Reserve, Global Monetary Superpower, PBoC, Uncategorized
Tagged , , , , , ,

Posted by Lars Christensen on September 8, 2016

https://marketmonetarist.com/2016/09/08/the-cost-of-the-sino-us-fx-deal-surging-money-market-rates-in-hong-kong/

In a deflationary world at the ZLB we need ‘competitive devaluations’

Sunday we got some bad news, which many wrongly will see as good news – this is from Reuters:

China and the United States on Sunday committed anew to refrain from competitive currency devaluations, and China said it would continue an orderly transition to a market-oriented exchange rate for the yuan CNY=CFXS.

…Both countries said they would “refrain from competitive devaluations and not target exchange rates for competitive purposes”, the fact sheet said.

Meanwhile, China would “continue an orderly transition to a market-determined exchange rate, enhancing two-way flexibility. China stresses that there is no basis for a sustained depreciation of the RMB (yuan). Both sides recognize the importance of clear policy communication.”

There is really nothing to celebrate here. The fact is that in a world where the largest and most important central banks in the world – including the Federal Reserve – continue to undershoot their inflation targets and where deflation remains a real threat any attempt – including using the exchange rate channel – to increase inflation expectations should be welcomed.

This of course is particularly important in a world where the ‘natural interest rate’ likely is quite close to zero and where policy rates are stuck very close to the Zero Lower Bound (ZLB). In such a world the exchange rate can be a highly useful instrument to curb deflationary pressures – as forcefully argued by for example Lars E. O. Svensson and Bennett McCallum.

In fact by agreeing not to use the exchange rate as a channel for easing monetary conditions the two most important ‘monetary superpowers’ in the world are sending a signal to the world that they are in fact not fully committed to fight deflationary pressures. That certainly is bad news – particularly because especially the Fed seems bewildered about conducting monetary policy in the present environment.

Furthermore, I am concerned that the Japanese government is in on this deal – at least indirectly – and that is why the Bank of Japan over the last couple of quarters seems to have allowed the yen to get significantly stronger, which effective has undermined BoJ chief Kuroda’s effort to hit BoJ’s 2% inflation target.

A couple of months ago we also got a very strong signal from ECB chief Mario Draghi that “competitive devaluations” should be avoided. Therefore there seems to be a broad consensus among the ‘Global Monetary Superpowers’ that currency fluctuation should be limited and that the exchange rate channel should not be used to fight devaluation pressures.

This in my view is extremely ill-advised and in this regard it should be noted that monetary easing if it leads to a weakening of the currency is not a beggar-thy-neighbour policy as it often wrongly is argued (see my arguments about this here).

Rather it could be a very effective way of increase inflationary expectations and that is exactly what we need now in a situation where central banks are struggling to figure out how to conduct monetary policy when interest rates are close the ZLB.

See some of my earlier posts on ‘currency war’/’competitive devaluations’ here:

Bernanke knows why ‘currency war’ is good news – US lawmakers don’t

‘The Myth of Currency War’

Don’t tell me the ‘currency war’ is bad for European exports – the one graph version

The New York Times joins the ‘currency war worriers’ – that is a mistake

The exchange rate fallacy: Currency war or a race to save the global economy?

Is monetary easing (devaluation) a hostile act?

Fiscal devaluation – a terrible idea that will never work

Mises was clueless about the effects of devaluation

Exchange rates and monetary policy – it’s not about competitiveness: Some Argentine lessons

The luck of the ‘Scandies’

 

2 Comments
by Lars Christensen on September 4, 2016  •  Permalink
Posted in Bank of Japan, Bennett McCallum, Currency war, ECB, Federal Reserve, Haruhiko Kuroda, Lars E. O. Svensson, Mario Draghi, PBoC, Uncategorized
Tagged , , , , , , ,

Posted by Lars Christensen on September 4, 2016

https://marketmonetarist.com/2016/09/04/in-a-deflationary-world-at-the-zlb-we-need-competitive-devaluations/

The verdict from G20 Money Base growth: Money is TIGHT

We hear it all the time – central banks are printing money like no time before and it is not working and now there is nothing more central banks around the world can do to fight deflation.

However, this is all a myth and this is what I will demonstrate in this post by looking at global money base growth.

We start by looking at the level of total money base of the G20 countries measured in US dollars.

G20 money base gap.jpg

The graph is clear – since early 2014 the G20 money base (denominated in US dollars) has flatlined.

Contrary to the popular perception there is not massive global money creation. Rather it is hardly surprising that we continue to see strong deflationary tendencies many places in the world as there essentially is no global money creation.

Now lets look at the same data now just in yearly growth rates instead of in levels.

G20 money base growth.jpg

Again the same picture emerges – G20 money base growth has come to a grinding halt particularly from early 2014, but in fact since early 2012 G20 money base growth has been below the pre-crisis growth rate of 15½% y/y.

Hence, it is very clear that judging from the G20 money base global monetary conditions have been tightening at least since early 2014. This of course coincide with when Janet Yellen became Federal Reserve Chair in February 2014 and US quantitative easing was coming to an end.

Ending quantitative easing in the US might or might not have been the right thing for the US economy, but it is clear that the impact on global money base growth has been significantly negative.

Tremendously stable global money base-velocity

Obviously one can question whether the money base is a good measure of monetary conditions. For this to be the case we would need to have a fairly stable development in global money demand and hence in global money base-velocity.

G20 base velocity

The graph above shows that G20 money base velocity in fact has followed tremendously stable development for the past 15 years.

Hence, over the past 15 years G20 money base-velocity has closely followed a downward trend declining on average 2,75% every quarter.

That said, since 2000 we of course have seen one major negative shock to G20 money base velocity in relationship to the onset of the Great Recession in October 2008 as the graph below  shows.

G20 velocity quarterly growth

However, from 2009 G20 money base-velocity developments more or less has been in line with the pre-crisis trend and as long as this continues to be the case I think it is fair to consider G20 money base growth as a reliable indicator of global monetary conditions. Not the only indicator, but certainly a very important indicator.

Money base slowdown at the core of the EM crisis and the drop in commodity prices

Having the sharp slowdown in G20 money base growth in mind it is hard to ignore that this more or less have coincided with a sharp drop in global commodity prices and considerable turmoil in Emerging Markets around the world.

Just have a look at the graph below.

CRB and G20 money base growth

There is far from a perfect correlation between commodity prices – he measured by Reuters CRB index – and G20 money base growth, but it is nonetheless notable that as G20 money base starts to slow down in early 2014 commodity prices fall of a cliff.

For the same reason I also think that it is wrong to attribute the drop in global commodity prices only to supply factors – such as Saudi Arabia’s oil policy or the return of Iran to the global oil markets. In fact I think the tightening of global monetary condition is the main cause of the drop in commodity prices since early 2014.

In the last couple of months we have seen a bit of a rebound in global commodity prices. This to some extent reflects supply side factors – such as increased tensions between Saudi Arabia and Iran – but again it is hard to ignore the fact that the outlook for G20 money base growth has changed in a slightly more positive direction as the Fed has softens its hawkish stance a bit.

That said, we haven’t seen a pick up in actual money base growth yet and unless we see that it is hard to see a more sustained recovery in commodity prices.

The question, however, remains whether we will actually see a pick-up in G20 money base growth going forward.

Three ways to higher G20 money base growth

Essentially there are three ways to higher G20 money base growth.

First, the Federal Reserve could re-start quantitative easing. That obviously would increase global money base growth, but right now it seems rather unlikely that the Fed is about to increase money base growth and the Fed still is overly hawkish.

Second, a sharp drop in the US dollar would by definition increase G20 money base growth denominated in US dollars, but again unless the Fed softens its rhetoric further we are unlikely to see any major correction in the dollar in the near-term.

Third, the other major central banks of the world could move into action and here I believe that it will be of particularly importance what the People’s Bank of China (PBoC) does with monetary policy. Here it is particularly notable that the PBoC has started to de-link the renminbi from the dollar and as such is gaining a larger degree of monetary sovereignty.

These three ways to increase money base growth also illustrate why the ‘dollar bloc’ is falling apart and more and more countries are likely to give up their close link to the dollar.

China has already started the process and a number of commodity exporters such as Kazakhstan, Azerbaijan and Angola have devalued their currencies substantially again the US dollar and other ‘dollar peggers’ are very likely to give up their close link to the dollar in the coming year – particularly if we do not see an increase in G20 money base growth either as a result of high US money base growth and/or a sharp drop in the value of the dollar.

Conclusion: Global monetary conditions have tightened considerably

So the conclusion is that global monetary conditions have been tightening significantly over the past two years and it is therefore hardly surprising that we have seen turmoil in Emerging Markets, collapsing commodity prices and continued global deflationary pressures.

We can see this by observing global financial markets, but as I have shown in this blog post the signal from G20 money base growth is also very clear and unless the major central banks of the world do not move into action to spur money base growth the global economy will continue be in a state of deflation.

It is about time for central banks around the world to acknowledge that they are far from helpless and take responsibility for ensuring nominal stability. Today central banks around the world unfortunately are failing to do so.

And no, negative interest rates will not do this – only more money creation will curb global deflationary pressures.

HT Jens Pedersen.

Update: the good thing about writing a blog is that you don’t have to worry about formalities, but on this one I would have put a source on the data. The source is IMF, local central banks, MacroBond and own calculations.

 

8 Comments
by Lars Christensen on May 15, 2016  •  Permalink
Posted in dollar bloc, Federal Reserve, PBoC, Uncategorized

Posted by Lars Christensen on May 15, 2016

https://marketmonetarist.com/2016/05/15/the-verdict-from-g20-money-base-growth-money-is-tight/

The ‘Dollar Bloc’ continues to fall apart – Azerbaijan floats the Manat

I have for sometime argued that the quasi-currency union ‘Dollar Bloc’ is not an Optimal Currency Area and that it therefore is doomed to fall apart.

The latest ‘member’ of the ‘Dollar Bloc’ left today. This is from Bloomberg:

Azerbaijan’s manat plunged to the weakest on record after the central bank relinquished control of its exchange rate, the latest crude producer to abandon a currency peg as oil prices slumped to the lowest in 11 years.

The third-biggest oil producer in the former Soviet Union moved to a free float on Monday to buttress the country’s foreign-exchange reserves and improve competitiveness amid “intensifying external economic shocks,” the central bank said in a statement. The manat, which has fallen in only one of the past 12 years, nosedived 32 percent to 1.5375 to the dollar as of 2:30 p.m. in the capital, Baku, according to data compiled by Bloomberg.

The Caspian Sea country joins a host of developing nations from Vietnam to Nigeria that have weakened their currencies this year after China devalued the yuan, commodities prices sank and the Federal Reserve prepared to raise interest rates. Azerbaijan burned through more than half of its central bank reserves to defend the manat after it was allowed to weaken about 25 percent in February as the aftershocks of the economic crisis in Russia rippled through former Kremlin satellites.

The list of de-peggers from the dollar grows longer by the day – Kazakhstan, Armenia, Angola and South Sudan (the list is longer…) have all devalued in recent months as have of course most importantly China.

It is the tribble-whammy of a stronger dollar (tighter US monetary conditions), lower oil prices and the Chinese de-coupling from the dollar, which is putting pressure on the oil exporting dollar peggers. Add to that many (most?) are struggling with serious structural problems and weak institutions.

This process will likely continue in the coming year and I find it harder and harder to believe that there will be any oil exporting countries that are pegged to the dollar in 12 months – at least not on the same strong level as today.

De-pegging from the dollar obviously is the right policy for commodity exporters given the structural slowdown in China, a strong dollar and the fact that most commodity exporters are out of sync with the US economy.

Therefore, commodity exporters should either float their currencies and implement some form of nominal GDP or nominal wage targeting or alternatively peg their currencies at a (much) weaker level against a basket of oil prices and other currencies reflecting these countries trading partners. This of course is what I have termed an Export Price Norm.

Unfortunately, most oil exporting countries seem completely unprepared for the collapse of the dollar bloc, but they could start reading here or drop me a mail (lacsen@gmail.com):

Oil-exporters need to rethink their monetary policy regimes

The Colombian central bank should have a look at the Export Price Norm

Ukraine should adopt an ‘Export Price Norm’

The RBA just reminded us about the “Export Price Norm”

The “Export Price Norm” saved Australia from the Great Recession

Should small open economies peg the currency to export prices?

Angola should adopt an ‘Export-Price-Norm’ to escape the ‘China shock’

Commodity prices, currencies and monetary policy

Malaysia should peg the renggit to the price of rubber and natural gas

The Cedi Panic: When prayers don’t work you go for currency controls

A modest proposal for post-Chavez monetary reform in Venezuela

“The Bacon Standard” (the PIG PEG) would have saved Denmark from the Great Depression

PEP, NGDPLT and (how to avoid) Russian monetary policy failure

Turning the Russian petro-monetary transmission mechanism upside-down

 

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

 

 

 

 

4 Comments
by Lars Christensen on December 21, 2015  •  Permalink
Posted in Azerbaijan, China, dollar bloc, Export Price Norm, PBoC, Peg the Export Price (PEP), Saudi Arabia, Uncategorized
Tagged , , , , , , , , , ,

Posted by Lars Christensen on December 21, 2015

https://marketmonetarist.com/2015/12/21/the-dollar-bloc-continues-to-fall-apart-azerbaijan-floats-the-manat/

The alarming drop in Chinese nominal GDP will force the PBoC to devalue again

I am in the US on a speaking tour at the moment so I have not had a lot of time for blogging, but I thought that I just wanted to share one alarming macroeconomic number with my readers – the sharp drop in Chinese nominal GDP growth.

ChinaNGDP

Yesterday we got the the Q3 numbers and as the graph shows the sharp slowdown in Chinese NGDP, which started in early 2013 continues. A similar trend by the way is visible in Chinese money supply data.

This is of course very clearly shows just how much Chinese monetary conditions have tightened over the past 2 years and this is of course also the main reason for the sell-off global commodity prices and in the Emerging Markets in the same period.

One thing in the number, which is interesting is that Chinese real GDP growth is now outpacing nominal GDP growth. As a consequence the Chinese GDP deflator has turned negative. Said in another way – China has deflation and in fact the pace of deflation is accelerating.

PBoC – it is time to let the Renminbi float

Even though the People’s Bank of China (PBoC) has devalued the Renminbi slightly against the dollar the PBoC still manages the Chinese currency tightly against the US dollar. As a consequence the PBoC continues to import the tightening of monetary condition from the US on the back of the sharp appreciation of the dollar over the past year or so.

However, China does not need monetary tightening. The sharp decline NGDP growth rather shows that China need monetary easing!

So unless Fed Chair Janet Yellen changes her mind and ease US monetary policy the PBoC will have to devalue the Renminbi again and potentially completely decouple from the dollar and letting the Renminbi float freely.

To me it is only a matter of time before we get another Chinese devaluation and that very well could spell the end to the ‘dollar bloc’ as we know and that certainly should be welcome. On the other hand if the PBoC does not realize the need to de-couple the Renminbi from the dollar then it is very likely that Chinese growth will slump further and it will then only be an question of time before Chinese goes into recession.

This topic will be central to my lecture at the Dallas Fed on Thursday. See here.

PS My US trip so far has been very inspiring and I hope in the coming weeks to share some of my impressions.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

4 Comments
by Lars Christensen on October 20, 2015  •  Permalink
Posted in Devaluation, dollar bloc, PBoC
Tagged , ,

Posted by Lars Christensen on October 20, 2015

https://marketmonetarist.com/2015/10/20/the-alarming-drop-in-chinese-nominal-gdp-will-force-the-pboc-to-devalue-again/

China: It just got worse – more bad news and more policy mistakes

It is becoming increasingly clear that the Chinese authorities are mismanaging the economic and financial situation and the risk that the authorities will to cause something to blow increases day by day.

First we had the ill-advised attempts to prop up the falling Chinese stock market by the Chinese authorities essentially buying stocks and by to some extent banning the selling of stocks.

Now the Chinese authorities are trying something even more stupid – shooting the messenger:

Chinese authorities have arrested nearly 200 people for alleged online rumor-mongering about China’s stock market turmoil and a recent, deadly chemical factory explosion in Tianjin.

Among the arrested is Wang Xiaolu, a journalist for financial publication Caijing Magazine, “who has been placed under ‘criminal compulsory measures’ for suspected violations of colluding with others and fabricating and spreading fake information on securities and futures market,” according to Chinese state media.

This smells of desperation and signals to global investors that the Chinese authorities really are clueless about what is going on in the economy and in the markets.

Obviously the Chinese stock markets are not falling because of “rumours”, but this is the well-known behavior of many governments around the world – when the markets are going up it is because of the great policies of the government, but when they are going down it is because of the evil actions of “speculators”.

Meanwhile the Chinese authorities are continuing to claim that everything is fine and that real GDP is growing above 7%. However, looking at all other indicators of Chinese growth it is clear that the Chinese economy is slowing fast and is growing much less than 7%.

Just take two sets of data published today. First of all, the final Caixin/Markit manufacturing purchasing managers’ index (PMI) dropped to 47.3 in August – the lowest reading since March 2009 and down from 47.8 in July.

Second and equally telling South Korean exports dropped as much as 14.7% y/y in August – much more than the consensus expectation of a 5.9% y/y drop. China of course is a key market for South Korean exports and South Korean export normally is a very good indicator of Chinese manufactoring activity.

Given the kind of drop in the Chinese stock markets we have seen in August and what the commodity markets are telling us and given the macroeconomic data coming out it is pretty hard to avoid the conclusion that China was hit by a “sudden stop” in August as we saw a serious escalation of the currency and capital outflows.

This is of course also what we have been seeing in the currency markets, where the Chinese authorities have been forced to allow the renminbi to weaken. The forward markets are telling us that more devaluations should be expected.

To make things worse we today got yet another policy failure when the People’s Bank of China (PBoC) in yet another attempt to make the problems go away announced that it will try to limit capital outflows by imposing a reserve requirement on financial institutions trading in foreign-exchange forwards for clients. This is essentially a form of currency controls.

This is of course just another attempt of trying to shoot the messenger. The markets are telling us that more devaluations are coming. How do you manage that problem? Shot down the market. Again this smells of panic and the likely consequence is to further escalate the outflows rather than the opposite.

But it not only smells of panic – it also is doing a lot of harm to the Chinese economy. Maybe paradoxically the small stepwise devaluations of the renminbi have signaled to the markets that more devaluations are coming and as a result this has escalated currency and capital outflows.

As a result the PBoC has had to do even more intervention in the currency markets to prop up the renminbi. This of course is essentially monetary tightening and the consequence will be a further slowdown of the Chinese economy and likely also more financial distress.

Let the RMB float!

This is also an important lessons to other “peggers”. There is no such thing as a small devaluation. Either you maintain your peg or you let you currency float.

So to me there is really only one way out of this problem for the Chinese authorities – stop the shenanigans and let the renminbi float freely!

This likely would lead to a major drop in the Chinese currency in the near-term, but the alternative is that the outflows continues and if the PBoC continues to intervene and continues to introduce draconian anti-market measures (such as jailing journalists and banding FX and equity selling) and then the crisis will just deepen.

The developments in the past few weeks have reminded us all that China really still very much is an Emerging Markets and that the Chinese authorities are much less in control of events than many people believed.

The Chinese authorities had it easy as long as the structural tailwinds kept the capital flows coming in and the US kept monetary policy easy. However, now we are seeing a sharp structural slowdown in the Chinese economy, currency outflows and an effective tightening of US monetary conditions. As a consequence it is becoming more and more evident that the Chinese authorities are not the supermen that they sometimes have been made up to be.

As I argued in my previous blog post this is essentially the ‘dollar bloc’, which is falling apart. If the Chinese authorities continues to try to fight the inevitable – a fairly large renminbi depreciation – then a lot more harm will be done to the Chinese economy and the risk of full-scale financial crisis increases dramatically.

We have it all here – monetary strangulation through a badly constructed monetary regime, political mismanagement and when the story of this crisis will be written I don’t doubt there will be lots of talk of moral hazard and cronyism as well. In fact when I watch the actions of the Chinese authorities I am reminded of the way the Suharto regime in Indonesia (mis)handled the crisis in 1997-98.

It was the same finger-pointing at “evil speculators” and the introduction of draconian and ill-advised methods to prop up the currency. In the end it all failed – the central bank was forced to allow a major devaluation, but only after an ill-fated attempt to prop up the currency more or less had blown up the financial system and caused a major contraction in the economy. And it was of course also an end of the Suharto regime (probably the most positive effect of the crisis).

The Chinese Communist party today should remember how and why Suharto’s regime fell apart. China can still avoid a Indonesian style crisis, but then the Chinese authorities should stop copying Suharto’s policies.

3 Comments
by Lars Christensen on September 1, 2015  •  Permalink
Posted in China, Indonesia, PBoC, Renminbi
Tagged , , , , ,

Posted by Lars Christensen on September 1, 2015

https://marketmonetarist.com/2015/09/01/china-it-just-got-worse-more-bad-news-and-more-policy-mistakes/

The ‘dollar bloc’ was never an optimal currency area and now it is falling apart

Global stock markets are in a 2008ish kind of crash today and I really don’t have much time to write this, but I just want to share my take on it.

To me this is fundamentally about the in-optimal currency union between the US and China. From 1995 until 2005 the Chinese renminbi was more or less completely pegged to the US dollar and then from 2005 until recently the People’s Bank of China implemented a gradual managed appreciation of the RMB against the dollar.

This was going well as long as supply side factors – the opening of the Chinese economy and the catching up process – helped Chinese growth.

Hence, China went through one long continues positive supply shock that lasted from the mid-1990s and until 2006 when Chinese trend growth started to slow. With a pegged exchange rate a positive supply causes a real appreciation of the currency. However, as RMB has been (quasi)pegged to the dollar this appreciation had to happen through domestic monetary easing and higher inflation and higher nominal GDP growth. This process was accelerated when China joined WTO in 2001.

As a consequence of the dollar peg and the long, gradual positive supply shock Chinese nominal GDP growth accelerated dramatically from 2000 until 2008.

However, underlying something was happening – Chinese trend growth was slowing due to negative supply side headwinds primarily less catch-up potential and the beginning impact of negative labour force growth and the financial markets have long ago realized that Chinese potential growth is going to slow rather dramatically in the coming decades.

As a consequence the potential for real appreciation of the renminbi is much smaller. In fact there might be good arguments for real depreciation as Chinese growth is fast falling below trend growth, while trend itself is slowing.

With an quasi-pegged exchange rate like the renminbi real depreciation will have to happen through lower inflation – hence through monetary tightening. And this I believe is part of what we have been seeing in the last 2-3 years.

The US and China is not an optimal currency area and therefore the renminbi should of course not be pegged to the dollar. That was a problem when monetary conditions became excessively easy in China ahead of 2008 (and that is a big part of the commodity boom in that period), but it is an even bigger problem now when China is facing structural headwinds.

Yellen was the trigger

Hence, the underlying cause of the sell-off we have seen recently in the Chinese and global stock markets really is a result of the fact that the US and China is not an optimal currency area and as Chinese trend growth is slowing monetary conditions is automatically tightened in China due to the quasi-peg against the dollar.

This of course is being made a lot worse by the fact that the Fed for some time has become increasingly hawkish, which as caused an strong appreciation of the dollar – and due to the quasi-peg also of the renminbi. And worse still – in July Fed chair Janet Yellen signaled that the Fed would likely hike the Fed funds rate in September. This to me was the trigger of the latest round of turmoil, but the origin of the problem is a structural slowdown in China and the fact China is not an optimal currency area.

China should de-peg and Yellen should postpone rate hikes

Obviously the Chinese authorities would love the Fed to postpone rate hikes or even ease monetary policy. This would clearly ease the pressures on the Chinese economy and markets, but it is also clear that the Fed of course should not conduct monetary policy for China.

So in the same way that it is a problem the Germany and Greece are in a monetary union together it is a problem that China and the US are in a quasi-currency union. Therefore, the Chinese should of course give up the dollar peg and let the renminbi float freely and my guess is that will be the outcome in the end. The only question is whether the Chinese authorities will blow up something on the way or not.

Finally, it is now also very clear that this is a global negative demand shock and this is having negative ramifications for US demand growth – this is clearly visible in today’s stock market crash, massively lower inflation expectations and the collapse of commodity prices. The Fed should ease rather than tighten monetary policy and the same goes for the ECB by the way. If the ECB and Fed fail to realize this then the risk of a 2008 style event increases dramatically.

We should remember today as the day where the ‘dollar bloc’ fell apart.

PS I have earlier argued that China might NEVER become biggest economy in the world. Recent events are a pretty good indication that that view is correct and I was equally right that you shouldn’t bet on a real appreciation of the renminbi.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

34 Comments
by Lars Christensen on August 24, 2015  •  Permalink
Posted in China, dollar bloc, Federal Reserve, In-optimal currency area, PBoC
Tagged , , , ,

Posted by Lars Christensen on August 24, 2015

https://marketmonetarist.com/2015/08/24/the-dollar-bloc-was-never-an-optimal-currency-area-and-now-it-is-falling-apart/

Malaysia has a freely floating Renggit – and thank god for that!

The Chinese surprise devaluation yesterday and has put currencies across Asia further under pressure. This is only a natural and the most stupid thing local Asian central bankers could do would be to fight it. Rather as China moves closer to a freely floating exchange rate it should inspire other Asian countries to do the same thing and I am therefore happy to see that the Vietnamese central bank this morning has widened the fluctuation band for the Dong and in that sense moved a bit closer to a freely floating Dong. Even though the hand has been forced somewhat by the PBoC’s devaluation yesterday it is nonetheless positive that we are seeing a move towards more freely floating exchange rates in Asia.

In that since it is not a “currency war”, but rather a liberation war, which in the end hopefully will secure monetary sovereignty to Asian nations such as Vietnam.

The floating Renggit is a blessing – also when it drops

This morning we are also seeing big moves in the Malaysian Renggit and the Renggit has already been under some pressure recently on the back of a worsening of Malaysia’s terms-of-trade and increased political uncertainty.

The sell-off in the Renggit has sparked some local concerns and the demands for the central bank to “do something” to prop up the Renggit are surely on the rise. However, it is extremely important to remember that the problem for Malaysia is not that the Renggit is weakening. Rarther the Renggit-weakness is a symptom of the shocks that have hit the Malaysian economy – lower commodity prices (Malaysia is a commodity exporter), increased political uncertainty and Chinese growth concerns.

None of this is good news for the Malaysian economy, but the fact that this is reflected in the Renggit is not a problem. Rather it would be a massive problem if Malaysia today had had a fixed exchange rate regime has was the case during the Asian crisis in 1997.

So the Malaysian central bank (BNM) should be saluted for sticking to the floating exchange rate policy, which has served Malaysia very well for nearly exactly a decade.

In fact BNM should move even closer to a purely free float and waste no opportunity to stress again and again that the value of the Renggit is determined by market forces and that the BNM’s sole purpose of monetary policy is to ensure nominal stability. The BNM should of course observe exchange rate developments in the sense it gives useful information about the monetary stance, but never again should the BNM try to peg or quasi-peg the Renggit to a foreign currency. That would be the recipe for disaster. As would such stupid ideas as currency and capital controls.

My friend Hishamh over at the Economics Malaysia blog has an extremely good post on his take on the Renggit situation. You should really read all of it. The post not only tells you why the freely floating Renggit is the right thing for Malaysia, but it is also extremely good in terms of making you understand why every (ok most…) countries in Asia should move in the direction of the kind of currency regime that they have in Malaysia.

Here is a bit of Hishamh’s excellent comments:

Another week, another multi-year low for the Ringgit. Since BNM appears to have stopped intervening, the Ringgit has continued to weaken against the USD, to what appears to be everyone’s consternation. There is this feeling that BNM should do something, anything, to halt the slide – cue: rumours over another Ringgit peg and capital controls.

To me, this is all a bit silly. Why should BNM lift a finger? Both economic theory and the empirical evidence is very clear – in the wake of a terms of trade shock, the real exchange rate should depreciate, even if it overshoots. NOT doing so would create a situation where the currency would be fundamentally overvalued, and we would therefore be risking another 1997-98 style crisis. Note the direction of causality here – it isn’t the weakening of the exchange rate that gave rise to the crisis, but rather the avoidance of the adjustment.

Pegging the currency under these circumstances would be spectacularly stupid. I’ll have more to say about this in my next post.

….

In the present circumstances, it’s not even clear why BNM should in fact intervene. You can make the argument that the Ringgit is fundamentally undervalued, and the FX market has overshot; but I have no idea why this is considered “bad”. If you want to live in a world of free capital flows, FX volatility is the price you pay.

… Malaysia’s latest numbers puts reserve cover at 7.6 months retained imports, and 1.1 times short term external debt, versus the international benchmark of 3 months and 1 times. Malaysia is at about par for the rest of the region, apart from outliers like Singapore and Japan.

Australia and France on the other hand, have just two months import cover, while the US, Canada and Germany keep just one month. You might argue that since these are advanced economies, there’s little concern over their international reserves. I would argue that that viewpoint is totally bogus. Debt defaults and currency crises were just as common in advanced economies under the Bretton Woods system. The lesson here is more about commitment to floating rather than the level of reserves. One can’t help but see the double standards involved here.

…All in all, this alarmism betrays a lack of general economic knowledge in Malaysia, even among people who should know better. Or maybe I’m being too harsh – it’s really a lack of knowledge of international macro and monetary economics.

…The Bank of Canada, the Reserve Bank of Australia, and the Reserve Bank of New Zealand, have all aggressively cut interest rates and talked down their own currencies – it’s the right thing to do in the face of a commodity price crash. BNM on the other hand has to walk and talk softly, softly, because Malaysians seem to think the Ringgit ought to defy economic laws.

Bravo! Please follow Hishamh! His blog posts are always good and insightful.

—-

If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

1 Comment
by Lars Christensen on August 12, 2015  •  Permalink
Posted in Dong, Malaysia, PBoC, Renggit, Uncategorized
Tagged , , , , , , ,

Posted by Lars Christensen on August 12, 2015

https://marketmonetarist.com/2015/08/12/malaysia-has-a-freely-floating-renggit-and-thank-god-for-that/

Don’t bet on a real appreciation of the renminbi

It rarely happens, but Scott Sumner and I do sometimes disagree on something.

Not surprisingly this time it is on a (mostly) non-monetary matter – the long-term outlook for the Chinese economy.

In my recent post I argued that China might NEVER become the largest economy in the world. Scott – a self-proclaimed Sinophile – strongly disagree with my claim. Here is Scott:

I have several problems with this argument.  First, if Lars really feels PPP is wrong, and that we should use nominal figures, then he should not be talking about China having recently grown at 7 to 7.5% per year.  In PPP terms China may have been growing at 7.5% vs. 2% in the US, but in nominal terms the gap is far wider, due to the Balassa-Samuelson effect.  China’s real exchange rate has appreciated strongly over the past decade.  So if Lars is right that nominal exchange rates are the right test, then China’s been catching up to the US at a rate far faster than either Lars or I assume. And in that case China’s nominal growth could slow dramatically and yet still be growing far faster than the US (where trend NGDP growth is now about 3%, in my view.)  Lars avoids this problem by assuming the Balassa-Samuelson effect will suddenly come to a screeching halt, whereas I think the yuan is headed to 4 to the dollar.  He also assumes a 3% RGDP growth rate for the US, whereas I believe it will be closer to 1.2%, growing over time to perhaps 2% in a few decades.

Other than it is a bit paradoxical that Scott aka Mr. NGDP is so eager to dismiss using nominal terms rather than real terms when it comes to comparing the absolute size of an economy the real disagreement comes down to whether there is a Balassa-Samuelson effect or not. According to the the BS effect relatively poorer countries – such as China – will see its exchange rate appreciate in real terms relative to richer countries such as the US.

In my China-post I assumed that there was no BS effect – and that the relative exchange rate between China and the US in the future would be determined by the Purchasing Power Parity (PPP). This assumption of course means that there is no difference whether we use real or nominal growth rates in GDP when comparing the relative size of the Chinese and the US economy (both measured in US dollars).

I acknowledged in my post that my no-BS effect assumption was a bit brave and I would happily agree that there is nothing theoretically wrong with the Balassa-Samuelson effect. However, I would also say that having worked professionally with forecasting Emerging Markets currencies for nearly 15 years I would be extremely skeptical about its importance of it from an empirical perspective. I will return to that below.

Scott often argues that the markets is the best thing we have to predict the future. I strongly agree with that. Despite of that Scott makes a bold prediction on the outlook for the Chinese renminbi.

Hence, Scott not only predicts a real appreciation of the renminbi, but he also argues “I think the yuan is headed to 4 to the dollar” – hence significant nominal appreciation.

That is an extremely bold prediction given USD/CNY today is trading around 6.15. Said in another way Scott is basically predicting a 50% appreciation of the renminbi! This is in direct contrast to what the markets are predicting. If we for example are looking at a 1-year forward for USD/CHY the market is now predicting around 2% depreciation of the renminbi. So we should ask Scott – do you believe markets are efficient or not?

A look at South Korea and Taiwan tells us we should not expect Chinese real appreciation

There is also another way to think about whether or not we will see a real Chinese appreciation or not in the coming decades and that is by looking at the experience of similar countries. China’s transition and its catching-up process is often compared to South Korea and Taiwan. Therefore, I have looked that the historical development in in the South Korean won and Taiwan dollar.

I have chosen 1990 as my “reference year”. The reason is that at that time South Korea’s and Taiwan’s GDP/capita relative to the US were more or less where Chinese GDP/capita is today compared to the US.

Lets first have a look at South Korea.

Real won.jpg

The first thing we see it that PPP seems to have been a pretty good “predictor” of the long-term development in the won over the long-term. I have calculated PPP based on the relative development in the GDP deflators in South Korea and the US.

But lets return to the question of real appreciation. Has there been a real appreciation of the won (against the dollar) since 1990? The answer is NO. In fact there has been a slight depreciation of the won in real terms.

But of course South Korea went through a major crisis in 1997 so it might be special. So lets instead look at Taiwan.

real TWD

Guess what? Since 1990 the Taiwan dollar has actually depreciated significantly in real terms against the US dollar. Maybe exactly because it has appreciated in the years ahead of 1990.

No matter the reason both the Taiwanese and the South Korean experience tell us that real currency appreciation is no given or automatic part of the catching up process for economies like South Korea, Taiwan or China.

A closer look at the renminbi’s recent real appreciation

In his comment Scott makes the following comment China’s recent appreciation of the renminbi:

“China’s real exchange rate has appreciated strongly over the past decade”

The graph below shows that Scott’s claim is correct.

Real CNY

But the graph also shows that the renminbi was more or less flat against the dollar in real terms from the early 1990s until 2005-6. Hence, we had at least 15 years of economic catch-up without any real appreciation of the CNY at all. Hence, again it is fair to argue that real appreciation does not automatically follow from economic catch-up. The period from 1990 to 2006 shows that quite clearly.

Furthermore, we want to ask ourself whether the real appreciation over the past decade really is a result of economic transition and catching up or something else. Hence, it is quite clear that over this period the People’s Bank of China have tried to curb inflationary pressures by undertaking a managed strengthening of the renminbi against the dollar – both in nominal and real terms. That process might now be coming to an end as the Chinese economy has slowed rather dramatically and inflationary pressures clearly have eased as well – particularly since 2011-12.

Finally let us again return to the examples of South Korea and Taiwan. The graph below shows the real exchanges of South Korea, Taiwan and China (against the US dollar). ‘Year zero’ is 1990 for South Korea and Taiwan, while ‘year zero’ is 2014 for China. Hence, the graph is “calibrated” so all three countries are at a similar income level versus the US in ‘year zero’.

Real KRW TWD CNY

 

I think the graph is quite telling – the appreciation of the renminbi over the past decade has been fairly similar in size to the appreciation in the in won and the Taiwanese dollar in the decade ahead of 1990. However, as also illustrated above that real appreciation didn’t continue. In fact a decade later both KRW and TWD had depreciated more than 10% in real terms against the US dollar.

This of course is not a prediction for what will happen – it is just an illustration that based on the experience of Taiwan and South Korea there is no reason to expect continued real appreciation of the renminbi.

So my message to Scott is – don’t bet on a real appreciation of the renminbi!

PS Scott uses the term yuan and I here have used the term renminbi. Renminbi is the official name for the Chinese currency and yuan is the main unit of currency.

5 Comments
by Lars Christensen on August 30, 2014  •  Permalink
Posted in China, PBoC
Tagged , , , , ,

Posted by Lars Christensen on August 30, 2014

https://marketmonetarist.com/2014/08/30/dont-bet-on-a-real-appreciation-of-the-renminbi/

The risk of Chinese monetary policy failure

Back in October 2012 I wrote a blog post on what I called “My favourite Chinese monetary graph“. In this post I am returning to this topic as I think the monetary developments in China has become increasing worrying.

My focus was on the development in M1:

Imagine a 4% inflation target – this year’s Chinese inflation target – trend real GDP growth 10-11% and money-velocity growth between -1% and 0% then the money supply (M1) should grow by 15-16% to ensure the inflation target  in the medium term. This is more or less a description of Chinese monetary policy over the past decade.

Over the past decade People’s Bank of China has been targeting M1 (and M2) growth exactly around 15-16% (give and take a bit…). Overall the PBoC has managed to hit its money supply target(s) and that has more or less ensured nominal stability in in China over the past decade.

I find it useful to track the growth of M1 versus two idealized targets path of 15% and 16% going back to 2000. This is my favourite graph for the Chinese economy.

This is how the updated M1 graph looks today:

M1 China Feb 2014

Back in October 2012 the actual level of M1 had just broken below the 16% trend line and since then M1 has kept inching downward compared to both the 16% and 15% trend lines and recently we have broken 15% tend line. This is obviously a very crude measure of monetary conditions in China, but I nonetheless think that the indication is pretty clear – monetary conditions are clearly getting tighter in China and I think it is fair to say that monetary conditions are disinflationary rather than inflationary.

Since my October 2012-post distress has clearly increased in the Chinese money markets and growth worries have certainly increased. Furthermore, given it is hard to ignore the connection between the continued tightening of monetary conditions in China and the turmoil we have seen in Emerging Markets over the past 6-12 months – after all China is a global monetary superpower.

It is time to ease Chinese monetary conditions 

I think that is totally appropriate that the People’s Bank of China (PBoC) initiated monetary tightening in early 2010 and overall the tightening has been warranted – even though it has had negative market implications for particularly some Emerging Markets. However, it is obviously not the task of the PBoC to conduct monetary policy for Brazil or Turkey for that matter. However, I think it is now pretty clear that Chinese monetary conditions has become too tight for China.

However, the PBoC has been extremely reluctant to step up monetary easing. In my view there are overall two reasons for this. First, PBoC obviously is worried that it could “reflate the bubble”. Second, the Chinese policy makers clearly seem to think that Chinese trend real GDP growth has declined and I would certainly agree that Chinese trend growth likely is closer to 7-8% y/y than to 10%.

So there likely has been good reason for a more cautious monetary policy approach in China, but if we indeed assume that Chinese trend growth has declined to for example 7-8% and money velocity on average decline 0-1% per year and the PBoC wants to hit 2-4%  inflation over the medium-term then M1 needs to growth by at least 9-13% (7+0+2 and 8+1+4).

Since October 2012 – when I put out my original post – Chinese M1 has actually averaged 9%, which is in the lower end of the range I think is necessary to avoid monetary policy to becoming excessively tight. Furthermore, it should be noted that the increased financial distress in China over the past year likely is pushing down both money velocity and the Chinese money multiplier, which in itself is disinflationary.

Concluding, I think there is little doubt that Chinese monetary conditions are becoming excessively tight – so far it is probably not catastrophic, but I can’t help thinking that the risk of nasty credit events increase significantly when economies go from a boom to a disinflationary weak growth scenario – said in another way I really fear is a “secondary deflation”.

PS A look at M2 growth would likely paint a slightly less scary picture.

PPS The growth rate of M1 in January 2014 was extremely weak (1.2% y/y). I am not certain what to make of the numbers, but it was what really got me to write this blog post.

14 Comments
by Lars Christensen on February 17, 2014  •  Permalink
Posted in China, PBoC
Tagged ,

Posted by Lars Christensen on February 17, 2014

https://marketmonetarist.com/2014/02/17/the-risk-of-chinese-monetary-policy-failure/

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