China: “No Float For You!”

There’s been no shortage of speculation about the veracity of China’s GDP data which many consider to be nothing short of make-believe.

Essentially, output is whatever the Politburo says it is, and attempting to guesstimate what the “real” figures are is an exercise in futility if you get paid to try and predict what the official numbers will ultimately be (i.e. if you’re a sellside economist).

Still, we have a laundry list of reasons to doubt the data. Some of these reasons point to a deliberate attempt on China’s part to paper over the facts and some of these reasons point to the difficulties of synthesizing data gathered from such a vast and disparate economy (one example of the latter is the possibility that Beijing isn’t measuring the deflator properly).

Whatever the case, it’s becoming increasingly clear that China cannot keep up the charade that is a 6.5% GDP print. Here’s SocGen:

The lack of credit deceleration so far points to a turn of the growth and inflation cycle in mid-2017 – one quarter later than we initially expected. But the cycle will turn nonetheless. The monetary policy stance has officially shifted from easy to neutral, and the authorities are sounding determined to contain asset bubbles and financial leverage. There have even been a few signals pointing to the potential acceptance of a growth rate below 6.5%. While we find the tone encouraging, the true test of this willingness will only come when economic growth starts to decelerate again in 2H17. We think that the arbitrary growth target will be given up – if not in 2017, then definitely in 2018. The harm of keeping it is all too apparent, for it has become not only an impediment to the necessary structural adjustments but also a culprit behind rapidly rising debt risk.

Of course one way to cushion the economy from the ongoing “hard landing” would be to float the RMB (assuming, that is, that doing so wouldn’t trigger a kind of nightmarish feedback loop causing capital outflows to spiral out of control). Indeed, SocGen has suggested that if a Trump administration starts a trade war, there’s a ~50% chance Beijing moves to a free float by the end of the calendar year.

Unsurprisingly, China isn’t too keen on letting that prediction stand unchallenged as it could well create more pressure on the currency in the near term thus making it more difficult for the PBoC to manage what is supposed to be a “controlled” devaluation. The reconstitution of the CFETS TWI basket (announced this week) is yet another effort to ensure that the yuan can continue to depreciate against the dollar even as it steadies against the country’s other trading partners.

In an apparent effort to counter “rumors” of a free floating RMB, Economic Information Daily (which one assumes is a Politburo mouthpiece) is out with the following amusing piece that carries the subtle title “RMB exchange rate should not be free to float.” Enjoy the Google translation below.

RMB exchange rate is a hot topic in 2016. With the RMB exchange rate approaching 7 this psychological barrier, the market interest in the devaluation of the renminbi heating up again, on the current gradual depreciation is sustainable, and whether the exchange rate should be allowed to freely float the discussion has become increasingly enthusiastic.

The author believes that, for three reasons, the current RMB exchange rate pegged to a basket of currencies should adhere to the regulation and control, rather than to the free float.

First, the current RMB exchange rate control model can be sustained. From the “811” exchange reform in 2015, the RMB exchange rate has undergone two stages: disorderly fluctuation and orderly fluctuation. August to December 2015, despite the cumulative consumption of 320.9 billion US dollars of foreign exchange reserves to stabilize the exchange rate, but the depreciation pressure is still difficult to ease. In January 2016 to November, with the strengthening of the central parity control, exchange rate movements back to controllable track. More importantly, by pegging to a basket of currencies, the strong appreciation of the dollar against the backdrop of the RMB depreciation is expected to remain stable.

Second, the free float may not be able to release the pressure of RMB devaluation, but will inevitably bring great risks. There are views that, as long as the free float of the RMB exchange rate, let the yuan debase in place will be able to release the devaluation pressure. But the exchange rate is not entirely determined by the economic fundamentals, the exchange rate movements will also affect the expected reaction in its own way.

In other words, the multiple equilibrium of self-fulfilling expectations is prevalent in the foreign exchange market. Moreover, the free floating exchange rate will usually be “overshoot”, a demoted most will be demoted too far. Therefore, the hope that a devaluation in place, in order to achieve the stability of the RMB exchange rate is unrealistic. On the contrary, the free floating, the exchange rate is bound to volatility, economic and financial impact is difficult to estimate. From the risks and benefits to consider the contrast, the current free floating RMB exchange rate is not wise.

Third, there is a need to stabilize the RMB exchange rate, filtering the impact of excessive fluctuations in the international foreign exchange market on China. According to the Bank for International Settlements (BIS), the average daily trading volume of the global foreign exchange market in 2016 exceeded US $ 5 trillion. While the current annual global GDP, but 70 trillion dollars to succeed. Obviously, in the foreign exchange market, a huge volume of transactions, non-fundamentals of speculative factors accounted for a large proportion. Especially after the sub-prime crisis, the world’s major central banks have adopted extremely loose monetary policy, exacerbated the global exchange rate volatility. In this context, to maintain the stability of the RMB exchange rate will help filter out the impact of external speculative shock on our country, to maintain domestic economic and financial stability.

Of course, the current exchange rate regulation is not without cost. In order to stabilize the exchange rate and consumption of foreign reserves and strengthen capital controls, has been criticized by many people. Near the year, the long-term exchange rate depreciation of the RMB is expected to significantly warming, indicating that the short-term stability of the exchange rate policy efforts have to increase. The free float of the RMB exchange rate seems to avoid these problems, but will lead to greater risks, the Chinese economy to pay a higher price.

Therefore, it is necessary to continue to maintain the control of the RMB exchange rate, increase policy efforts to curb the depreciation of the RMB is expected. 3 trillion US dollars of foreign reserves in the hands of the Chinese government is a “trump card.” But if you are always tied, the card does not play, the trump card will eventually become a waste. Taking into account the Trump initiative of the loose fiscal bound to substantially increase the level of US Treasury bonds, and a stronger dollar, higher interest rates will inevitably have a negative impact on the US economy, the current US dollar rally is not sustainable. In the current juncture, strengthening the RMB exchange rate control policy is the best policy.

Or, summarized with a Seinfeld reference…

foat

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