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Monday, September 28, 2015

China's Economic Woes.

A friend of mine says that China's best days are right now: a host of demographic and related issues are going to hobble the Middle Kingdom over the medium to long term.

And perhaps the first signs of it are occurring right now: according to this long but very interesting piece, the People's Republic has spent and Marxed itself into one huge mess. Here's just a small (no, really!) helping, explaining China's currency peg trap.

Why does China insist on continuing its currency peg? The direct answer is that maintaining capital controls requires maintaining the peg, if China is to have control over its monetary policy. Why does China insist on continuing capital controls? This again stems from the weakness of the Chinese system.

China’s long-term interest lies in abandoning the capital controls outright. This would eventually stabilize the RMB, and make Chinese assets more valuable due to a liquidity premium (investors are more likely to enter if they are not prohibited from exit). In the near-term, however, abandoning capital controls would cause a sudden, massive flight of capital out of China. That would surely prick the property bubble, and the ensuing instability would threaten the Communist Party.

Again, SocGen’s Wei Yao: “Not letting the currency go requires significant FX intervention that will not prevent ongoing capital outflows but which will result in tightening domestic liquidity conditions; but letting the currency go risks more immense capital outflow pressures in the immediate short term, external debt defaults and possibly further domestic investment deceleration.”
Another factor in the continuation of capital controls and the currency peg must be the dollar-denominated debt of many Chinese firms. Pundits have pointed out that Chinese foreign-currency debt is nothing compared to the degree of dollar debt that precipitated the 1997 Asian Financial Crisis.

True, but many Chinese issuers of dollar bonds are firms in the all important real-estate sector. Nomura, a bank, estimates external liabilities amount to $1.135 trillion, $405 billion of which is bond issuance, the rest being international bank loans. Mingtiandi, a Chinese real-estate intelligence firm, estimates that over a third of developer debt is not in RMB. Jeffries and JP Morgan put total developer debt exposed to the dollar even higher, at 40 percent.

The devaluation was in small part a warning to property-sector issuers of dollar debt who have not hedged against RMB depreciation.
As such, the recent RMB devaluation should be thought of in two ways. It was not a sop to exporters, nor was it an attempt to allow market forces to more greatly sway the RMB. Rather, the devaluation was in small part a warning to property-sector issuers of dollar debt who have not hedged against RMB depreciation, and was in large part due to the PBOC’s peg pulling too much RMB out of the economy. There will be more devaluation.

But keeping the peg in place and allowing what looks to the market like knee-jerk devaluations only makes investors place more bets on a falling RMB, which further goads capital flight. Citigroup analysts write that, “After [the] recent FX regime shift, it’s also not realistic to assume the renminbi should stabilize after [a] mere 3 per cent depreciation.” SocGen projects a further 6.2 percent depreciation by the end of the year. In other words, unless the PBOC abandons the currency peg altogether, thus abandoning capital controls, it is backed into a corner.

Instead of the quick knock on the head that liberalizing capital controls would bring, along with allowing the RMB to float, China is opting for a slow and excruciating monetary strangulation. When the property bubble does burst, Chinese consumer spending will be radically reduced in a reverse wealth effect as savings are wiped out. In the words of hedge fund manager James Chanos, China is on a “treadmill to hell” because of the “heroin of property development.”

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