I can summarize all of China’s problems in one sentence: Beijing is trying to delver and releverage simultaneously.
That’s the crux of the problem for the PBoC.
See the thing is, everyone already thinks the notion that the Chinese economy is growing at a ~6.5% clip is absurd. If you start aggressively reining in credit creation (i.e. if we start seeing big declines in TSF), then the charade will be impossible to keep up. Additionally, the Politburo is well aware of the fact that when it comes to the global credit impulse, that too is “made in China” (to quote Citi’s Matt King)…
(Citi)
So if you’re China, you need to keep the credit party going not just for your own sake, but for the sake of the global economy.
But that clashes with the necessity of purging overcapacity sectors whose overproduction contributes to deflation. China really, really needs to embark on SOE reform, but doing that requires doing away with the implied government backstop on those companies and that leads to rising defaults. Rising defaults are no good because a default cycle would threaten to expose the fact that Chinese banks’ headline NPL numbers are for all intents and purposes fictitious (just ask Kyle Bass) and on top of that, there’s no telling how much SOE debt is embedded in the country’s labyrinthine shadow banking complex which has come under intense scrutiny of late.
Meanwhile, the PBoC is attempting a managed devaluation of the yuan. This was a veritable disaster from the word go, triggering a global market bloodbath on August 24, 2015 and catalyzing another stretch of turmoil in January 2016, a month after the PBoC telegraphed still more yuan weakness on the horizon by adopting a trade-weighted reference basket.
All of this fits together in a kind of nightmarish doom loop, where misallocated domestic capital fuels asset bubbles which in turn causes capital flight, which exacerbates pressure on the yuan causing the PBoC to burn still more FX reserves (i.e. sell US Treasurys), which then freaks people out even more, causing more capital flight and a concurrent tightening of capital controls which (again) causes more capital flight… and around we f*cking go.
All of that sounds complicated, and it is until you study it enough to be able to recount the narrative quickly, but fortunately, SocGen is here to help. Consider the following great chart which illustrates the above-mentioned doom loop. I’ve also included some color from the bank on why a one-off depreciation of the RMB (a frequently debated “cure-all” for China’s problems) would probably be a disaster.
Via SocGen
In light of the limited two-way risk in the RMB exchange rate, one oft-mentioned proposal by market participants is that the PBoC should just take a leap of faith and embrace a big devaluation, and then the currency would automatically stabilise around a new level and there would finally be two-way risk.
Aside from the political fallout with the Trump administration and the great shock it would cause to the global financial market, we doubt that such a move would bring any economic benefit to China anyway. Furthermore, with significant uncertainty as to what the market clearing level is, it is unlikely that the authorities’ could properly calibrate the magnitude of any depreciation without causing more outflow risks or economic damage. Rather than endorsing the view that all the outflow or depreciation pressure would be effectively eliminated by such a move, we take the contrary position and believe that a big devaluation might turn out instead be the final straw on the camel’s back of China’s credit bubble, leading to an even greater crisis.
Dear H,
I really do…..no sarcasm…… enjoy reading your posts but, there is always a but ( being Swedish), I do find it difficult at times to undestand your abbreviations. Would really really appreciate if you could consider giving a short explanation to the not so obvious ones I cannot find in Investopedia.
Best Regards, JP
SOE – State-Owned Enterprises
NPL – Non-Performing Loans
PBoC – Peoples’ Bank of China
RMB – “Renminbi” is the official name of the currency introduced by the Communist People’s Republic of China at the time of its foundation in 1949. It means “the people’s currency”. “Yuan” is the name of a unit of the renminbi currency. Something may cost one yuan or 10 yuan.
BIS – Bank for International Settlements
ECB – European Central Bank
MSCI – Morgan Stanley Capital International
Fed – US Federal Reserve
… hope this helps …