Why China is blamed for wacky market moves

[LeveragedBuyout]

Why China is blamed for wacky market moves
By Saumya Vaishampayan and Ben Eisen, MarketWatch

NEW YORK (MarketWatch) — China’s efforts to weaken its currency could be bolstering U.S. Treasurys and weighing on a rally in the dollar against the euro.

The Asian nation’s currency actions, thought to be an effort to boost its slowing economy, have contributed to these unlikely trading patterns, market participants say. It’s the latest way in which China’s economy has become intertwined with the U.S., five years after an American real estate bust elicited finger-pointing at the role Chinese funds played in cheap U.S. mortgages.

The 10-year Treasury (ICAPSD:10_YEAR) yield fell from over 3% at the start of the year to an 11-month low of 2.44% at the end of the May; it more recently traded at 2.60%. The push lower in yields came even amid signs that the U.S. labor market recovery is picking up. All things being equal, yields were primed to rise.

The dollar (ICAP:EURUSD) has similarly moved at cross-purposes to what’s expected as the economy strengthens and the Federal Reserve starts to tighten monetary policy. The dollar fell 0.2% against the euro in the first quarter, even as declining euro-zone inflation made it more likely that the European Central Bank would have to ease further. The dollar is up 1.5% against the euro this year, a modest bump compared to expectations.

As U.S. Treasury yields have fallen this year, companies and consumers have found it less expensive to borrow money. Simultaneously, the lack of a major dollar rally against the euro means that U.S. exports are more competitive than they were expected to be.

Among the variety of explanations, demand from China continues to grab the attention of traders and strategists. It starts with the depreciation of the Chinese yuan(ICAP:USDCNY) against the dollar in 2014. Some attributed the move to the government’s desire to shake out speculators betting on a continued rise in the Chinese currency, while others point to the fact that a weaker currency makes Chinese exports more attractive. Whatever the reason, the dollar rose 2.7% against the yuan in the first quarter of 2014, marking the first quarterly gain since the three months ended June 2012, according to FactSet data.

To accomplish that depreciation, China has sold yuan and bought dollars, leaving it with a huge pile of American currency in its reserve. In the first quarter, China’s official data show its foreign-exchange reserves rose by $129 billion to $3.95 trillion, touching an all-time high.

From MarketWatch in Hong Kong: China’s falling yuan may be policy driven

By most accounts, China likely doesn’t want to keep its increased stash of greenbacks. Traders and market participants on the front lines speculate that the U.S. dollars have been used to buy U.S. Treasurys and have been swapped for euros, adding to demand in those markets.

“You can be reasonably comfortable saying they buy a lot of Treasurys, diversify a lot into euros,” said Steven Englander, head of G10 foreign-exchange strategy at Citi, referring to the Chinese.

Of course, it’s difficult to attach changes in China’s reserves to any specific market movements because the data is lagged. But when markets act up, the “China explanation” tends to lurk.

“The Chinese economy and Chinese demand for U.S. Treasurys is significant in the big picture,” said Gregory Whiteley, government bond portfolio manager at DoubleLine Capital LP.

But there are also sceptics who argue that the influence of China is too readily given.

“Generally, you talk about China when you don’t know what’s happening,” said Sebastien Galy, senior foreign-exchange strategist at Societe Generale. “It’s a nice story and completely unverifiable,” he said.

The Belgium gambit
One way to gauge flows is by looking at Treasury International Capital data, which break down U.S. government debt holdings by country each month. But the data is released with a two-month lag, and can include securities in one country that are actually being held in custody for another country, called a custodian bias.

China’s official holdings of Treasurys moderated in March, but at the same time, Belgium’s holdings have surged, making the tiny European country the third largest holder of U.S. debt, according to Treasury International Capital data from March that was released in May, the latest available. The combined rise of U.S. debt held by China and Belgium tracks the growth in foreign exchange reserves, according to data from Wrightson ICAP LLC. That suggests China may be buying Treasurys under the guise of a different nationality.


Euroclear, a Belgium-based securities depository and custody provider, is often cited as a potential channel through which Treasurys are bought.

“You can make a circumstantial case that the fact that China’s reported holdings leveled off about the time Belgium’s holdings were exploding, and the fact that China was expanding reserves makes that a possibility,” said Lou Crandall, chief economist at Wrightson ICAP LLC. But Crandall emphasizes that while these flows are all possible, the lack of data makes it difficult to confirm.

---

China and the US: it's a complicated relationship.

 

[Chinese-Dragon]

While America devalues their own dollar, with "quantitative easing". Which also has the nasty side effects of sending huge amounts of inflation into the developing world, and also acts as a stealth tax on any country that holds dollars (basically every country).

It’s the latest way in which China’s economy has become intertwined with the U.S., five years after an American real estate bust elicited finger-pointing at the role Chinese funds played in cheap U.S. mortgages.

This has always been the most baffling argument to me.

China has huge surpluses and huge reserves, therefore we are to blame when America spends beyond it's means and falls into massive debt?

Yes, our surpluses and reserves mean that money is cheaper to borrow on a worldwide basis. That doesn't mean America suddenly has to go out and get into huge debt!

 

[LeveragedBuyout]

While America devalues their own dollar, with "quantitative easing", which has the side effect of sending huge amounts of inflation into the developing world, and also acts as a stealth tax on any country that holds dollars (basically every country).



This has always been the most baffling argument to me.

China has huge surpluses and huge reserves, therefore we are to blame when America spends beyond it's means and falls into massive debt?

Yes, our surpluses and reserves mean that money is cheaper to borrow on a worldwide basis. That doesn't mean America suddenly has to go out and get into huge debt!

China prevents the USD from devaluing against the RMB (thus the build up of reserves). Until China floats the RMB, this won't change.

As far as blaming China for low interest rates, you're preaching to the choir. First: thank you, China. Second: it is human nature, especially for left-wingers, to blame someone else for their own problems. No one put a gun to their head and forced them to lie about their income on their mortgage applications and then buy a bigger house than they could afford. But as long as Democrats bribe the electorate with handouts and direct their anger against capitalists and China, there's nothing to be done. When the Democratic Party is annihilated, the American economy will finally improve.

Here is a related article, focusing on China's equity market. @Chinese-Dragon, I think the part I set in bold essentially mirrors what you were saying earlier.

China’s missing reform rally - MarketWatch

June 15, 2014, 11:31 p.m. EDT

China’s missing reform rally
Commentary: Is state capitalism here to stay?
By Craig Stephen

HONG KONG (MarketWatch) — A popular theme for investors is buying into reform-minded governments as they take up the reins of power. This strategy would have made money with 2 out of the 3 biggest economies of Asia. China has been the odd one out, but is it time for this anomaly to be reversed?

Japan, China and India have all seen new governments taking office, promising far-reaching economic reform. For India and Japan, the arrival of prime ministers Narendra Modi and Shinzo Abe, respectively, and their promises of reform were accompanied by impressive stock-market rallies.

Yet some analysts argue that those hoping reform will make China look more like a free-market economy will only be disappointed.

Author and former analyst Joe Zhang — in his new book “Party Man, Company Man: Is China’s State Capitalism Doomed?” — says the state’s domination of the economy will continue as reform takes a back seat.

Last November, the foreign media published lengthy analysis of Third Plenum policy documents forecasting transformational changes in China, but Zhang says he saw nothing different from what was said in previous years. His skepticism is partly formed from his experience working at various state-owned enterprises, as well as at China’s central bank.

He says it’s easy to be misled by focusing on grand statements coming from Chinese politicians. For instance, how many times get former premier Wen Jiabao’s comments that China’s economy was “unbalanced, unstable and unhealthy” repeated? And yet this self-criticism was not matched by policy change.

However, Zhang also believes that state capitalism works rather better than most Western analysts give it credit for. Further, given China’s most pressing problems of resource depletion, pollution and income inequality, a strong state sector can actually be an asset.

Whether or not you agree with this perspective, it is much harder to argue that China’s current model is good for equity investors. State-capitalist companies is what you get in China’s domestic stock markets, with approximately 75% of the market capitalization related to SOEs.

Too often, the interests of minority investors will be at or near the back of the line, behind the party, the state and management. This is unlikely to change on the current course.

Meanwhile, China’s financial-market reform may also flatter to deceive.

I spoke with one seasoned trader recently who made an interesting distinction between the way China and India were proceeding with capital-account reform. India’s he said, was more risky and harder to reverse as it was happening onshore, while China’s was going down a path of offshore reform. The latter could still be switched off in an instant, he reckoned, if China got cold feet.

Zhang’s conclusion is that China will likely “muddle through” with pragmatic policy tinkering. This would suggest the wait for China’s reform rally could well be a long one.

 

[Chinese-Dragon]

Author and former analyst Joe Zhang — in his new book “Party Man, Company Man: Is China’s State Capitalism Doomed?” — says the state’s domination of the economy will continue as reform takes a back seat.

Last November, the foreign media published lengthy analysis of Third Plenum policy documents forecasting transformational changes in China, but Zhang says he saw nothing different from what was said in previous years. His skepticism is partly formed from his experience working at various state-owned enterprises, as well as at China’s central bank.

He says it’s easy to be misled by focusing on grand statements coming from Chinese politicians. For instance, how many times get former premier Wen Jiabao’s comments that China’s economy was “unbalanced, unstable and unhealthy” repeated? And yet this self-criticism was not matched by policy change.

However, Zhang also believes that state capitalism works rather better than most Western analysts give it credit for. Further, given China’s most pressing problems of resource depletion, pollution and income inequality, a strong state sector can actually be an asset.

Before you were talking about the "allocation of resources".

Yes, it is generally true that the private sector is more "efficient" at allocating resources. No doubt.

However, China is still a developing country. What is efficient for corporate profit, may not necessarily be to the benefit of China's economic development as a whole.

The state capitalist model allows the Government to accumulate vast economic resources, and allocate them as it sees fit. In many cases throughout history, this "allocation" has been into the pockets of corrupt officials, and there is no doubt that China has a huge amount of corruption, even my own city HK has vast corruption. In other cases, state capitalist governments have allocated these resources into military and territorial expansion, running up massive defence spending.

However (in my opinion anyway), this is not what is generally happening in China. The defence budget is very low compared to the amount of resources the government spends, and despite widespread corruption, the top level of leadership are generally not that wealthy, not compared to leaders in other countries especially.

What I see, is the Chinese government using the vast amount of economic resources they control, to develop China. This includes the state-owned banks, who were used for example to stop China going into recession during the 2008 Credit crunch, and will most likely continue to be used as policy instruments into the future.

The Chinese government knows that the best way for them to maintain their legitimacy, is to deliver on economic growth and economic development in China, which is what benefits the common person on the street. Which is why economic development has been their primary goal now for a long time, and why they often ruthlessly crack down on corrupt officials, with very harsh penalties (such as suspended death sentences).

Thus, a state capitalist model may be what is more useful to us, while we are still a developing economy. After we become a developed country, this may change, depending on circumstances.

 

[LeveragedBuyout]

Before you were talking about the "allocation of resources".

Yes, it is generally true that the private sector is more "efficient" at allocating resources. No doubt.

However, China is still a developing country. What is efficient for corporate profit, may not necessarily be to the benefit of China's economic development as a whole.

The state capitalist model allows the Government to accumulate vast economic resources, and allocate them as it sees fit. In many cases throughout history, this "allocation" has been into the pockets of corrupt officials, and there is no doubt that China has a huge amount of corruption, even my own city HK has vast corruption. In other cases, state capitalist governments have allocated these resources into military and territorial expansion, running up massive defence spending.

However (in my opinion anyway), this is not what is generally happening in China. The defence budget is very low compared to the amount of resources the government spends, and despite widespread corruption, the top level of leadership are generally not that wealthy, not compared to leaders in other countries especially.

What I see, is the Chinese government using the vast amount of economic resources they control, to develop China. This includes the state-owned banks, who were used for example to stop China going into recession during the 2008 Credit crunch, and will most likely continue to be used as policy instruments into the future.

The Chinese government knows that the best way for them to maintain their legitimacy, is to deliver on economic growth and economic development in China, which is what benefits the common person on the street. Which is why economic development has been their primary goal now for a long time, and why they often ruthlessly crack down on corrupt officials, with very harsh penalties (such as suspended death sentences).

Thus, a state capitalist model may be what is more useful to us, while we are still a developing economy. After we become a developed country, this may change, depending on circumstances.

All good points. I desperately need to get to sleep, so I can't do the research now, but the fear for China is that while state capitalism has worked well for China, it may pose a future threat to China in the same way that Japan's zaibatsu/keiretsu and Korea's chaebol have come to dominate (and in some cases, strangle) their respective economies. Due to their size and influence in their economies, Japan, and recently South Korea, have found that enacting economic reform has become an intractable problem. SOEs in China may eventually pose the same threat, so the thinking is that it's easier to reform now, before they become too dominant, rather than later. Right now, the SOEs are an efficient way for the party to direct the economy, but as China conducts more R&D and increases its service sector, the competition and innovation provided by SMEs will become increasingly critical. SOEs take too much capital and don't leave enough for the SMEs, which is one of the current friction points in the Chinese economy at the moment--but I am not telling you anything you don't already know.

I will try and pull some studies when I have a chance.

 

[Chinese-Dragon]

All good points. I desperately need to get to sleep, so I can't do the research now, but the fear for China is that while state capitalism has worked well for China, it may pose a future threat to China in the same way that Japan's zaibatsu/keiretsu and Korea's chaebol have come to dominate (and in some cases, strangle) their respective economies. Due to their size and influence in their economies, Japan, and recently South Korea, have found that enacting economic reform has become an intractable problem. SOEs in China may eventually pose the same threat, so the thinking is that it's easier to reform now, before they become too dominant, rather than later. Right now, the SOEs are an efficient way for the party to direct the economy, but as China conducts more R&D and increases its service sector, the competition and innovation provided by SMEs will become increasingly critical. SOEs take too much capital and don't leave enough for the SMEs, which is one of the current friction points in the Chinese economy at the moment--but I am not telling you anything you don't already know.

I will try and pull some studies when I have a chance.

Yes, reform is necessary now, and will continue to be necessary in the future. The Chinese government's legitimacy is dependent on economic development, I would say more so than in most other countries.

Since failing is not like losing an election in another country, where you can recoup and try again in four years. Needless to say, the consequences for failure in our current system are much more severe.

Anyway, the announced economic reforms do make mention of some degree of privatization in the banking sector.

It doesn't grab headlines like the announced reforms on interest rate and currency liberalization, but it is still a big part of it:

BBC News - China plans new privately financed banks

Opening up the banking sector in particular, is a huge deal in a state capitalist system. So these reforms will likely be slow and steady, to allow the giant SOE's in the banking sector time to adjust to the new private players.

 

[Mr.S.Singh]

Yes, reform is necessary now, and will continue to be necessary in the future. The Chinese government's legitimacy is dependent on economic development, I would say more so than in most other countries.

Since failing is not like losing an election in another country, where you can recoup and try again in four years. Needless to say, the consequences for failure in our current system are much more severe.

Anyway, the announced economic reforms do make mention of some degree of privatization in the banking sector.

It doesn't grab headlines like the announced reforms on interest rate and currency liberalization, but it is still a big part of it:

BBC News - China plans new privately financed banks

Opening up the banking sector in particular, is a huge deal in a state capitalist system. So these reforms will likely be slow and steady, to allow the giant SOE's in the banking sector time to adjust to the new private players.

One can only wait and see the rules and regulation that would regulate the banks too see the extent of liberalization in banking.
As far as your previous argument goes, Yuan's true value cannot be ascertained unless it follows a free floating.

 

[Chinese-Dragon]

One can only wait and see the rules and regulation that would regulate the banks too see the extent of liberalization in banking.
As far as your previous argument goes, Yuan's true value cannot be ascertained unless it follows a free floating.

Our economic reforms will take place over the next few years, including liberalization of the Yuan.

Anyway, even free floating currency regime may not necessarily reflect the true value of a currency.

The Indian Rupee for example took a pretty big nosedive after the US hinted they would reduce their stimulus program a while back.

The Indian government responded with capital account controls, interest rate changes, and even direct intervention in the markets using their currency reserves. They also encouraged people to stop importing gold.

Whereas the USA and Japan use quantitative easing to help devalue their currencies.

So it's a complicated issue, all major countries have a variety of tricks in their bags to influence the value of their currencies, even if they are nominally free floating. China will likely be the same, even after our reforms.

 

[Mr.S.Singh]

Our economic reforms will take place over the next few years, including liberalization of the Yuan.

Anyway, even free floating currency regime may not necessarily reflect the true value of a currency.

Wrong

The Indian Rupee for example took a pretty big nosedive after the US hinted they would reduce their stimulus program a while back.

True .. because easy finance flowed into Indian market when Fed bought bonds. With tapering this easy finance will stop

The Indian government responded with capital account controls, interest rate changes, and even direct intervention in the markets using their currency reserves. They also encouraged people to stop importing gold.

Easy flow of capital into Indian economy helped Indian govt to ease with capital control, when it stopped we needed to take measures. Our balance of payment is negative ... we a capital deficit state, hence counter measures after tapering had to be taken. We are second largest importers of gold, and the largest home based consumer, with a capital deficit obviously duty for gold had to be raised

Whereas the USA and Japan use quantitative easing to help devalue their currencies.

QE is an extreme measure, QEing could aggravate inflation levels in India more. Indians anyways save the most, hence all we needed has to control the banking borrowing and lending. Infact, most banks now offer 6% interest rates on Saving and around9-10% on Fixed Deposits

So it's a complicated issue, all major countries have a variety of tricks in their bags to influence the value of their currencies, even if they are nominally free floating. China will likely be the same, even after our reforms.

Agreed, but China will not face devaluation due to US tapering because of a positive balance of payment, it can only face devaluation of terms of economic figure and mortgage rates

 

[Chinese-Dragon]

Wrong



True .. because easy finance flowed into Indian market when Fed bought bonds. With tapering this easy finance will stop


Easy flow of capital into Indian economy helped Indian govt to ease with capital control, when it stopped we needed to take measures. Our balance of payment is negative ... we a capital deficit state, hence counter measures after tapering had to be taken. We are second largest importers of gold, and the largest home based consumer, with a capital deficit obviously duty for gold had to be raised

Free floating does not necessarily show the true value of a currency, because major governments are constantly intervening in the value of their currency, China, India and America being the examples in this thread.

America's quantitative easing alone, skews not only the value of their own currency, but others as well, as we have seen with the Rupee, and various other emerging market currencies (the "Fragile Five" especially).

 

[Mr.S.Singh]

Free floating does not necessarily show the true value of a currency, because major governments are constantly intervening in the value of their currency, China, India and America being the examples in this thread.

Yes, but it does show the most fair value, under freefloat, inflations figures, job creation, etc all reflect in your currency value .. The yuan if free floated would gain against the dollar tremendously and then on start falling/ stabalizing as economic figures comeout .. if china continues 7% growth YoY basis it will become stronger vs Dollar as GDP rises.

America's quantitative easing alone, skews not only the value of their own currency, but others as well, as we have seen with the Rupee, and various other emerging market currencies (the "Fragile Five" especially).

few points

Because dollar is universally traded currency, its QE will effect all currency, China to if it was under free float
QE comes along with restriction of investment in US only (discouraging investments in other countries), hence drying up currency outflow ... taking up lending rates and hampering growth in the fragile 5

But this is a good thing because our markets see's immediate correction and is reset. It is a natural process of correction which avoids to create a bubble.

 

[Chinese-Dragon]

Yes, but it does show the most fair value, under freefloat, inflations figures, job creation, etc all reflect in your currency value .. The yuan if free floated would gain against the dollar tremendously and then on start falling/ stabalizing as economic figures comeout .. if china continues 7% growth YoY basis it will become stronger vs Dollar as GDP rises.


few points

Because dollar is universally traded currency, its QE will effect all currency, China to if it was under free float
QE comes along with restriction of investment in US only (discouraging investments in other countries), hence drying up currency outflow ... taking up lending rates and hampering growth in the fragile 5

But this is a good thing because our markets see's immediate correction and is reset. It is a natural process of correction which avoids to create a bubble.

Well, the Yuan will be liberalized in the next 2-5 years, so we will see it for ourselves eventually.

And yes, the Yuan probably will appreciate in value, though to what degree is uncertain.

Hopefully our economic shift away from an investment-driven economy to a more consumption-driven economy, would show good results in time for the currency and interest rate liberalization.

 

[Mr.S.Singh]

Well, the Yuan will be liberalized in the next 2-5 years, so we will see it for ourselves eventually.

And yes, the Yuan probably will appreciate in value, though to what degree is uncertain.

Hopefully our economic shift away from an investment-driven economy to a more consumption-driven economy, would show good results in time for the currency and interest rate liberalization.

China would need to liberalize its financial system to move to a consumer driven economy, when taking about consumption .. it is not only products but financial services that are consumed such as bonds and shares. Now a free primary and secondary market including money market for short term loans would be needed to run free with a free hand. If you ask me, china should slowly start pulling out of these market and monitor them so that by liberalization takes place these markets would be ready to raise huge amount of money. Mind you these markets would be needed to raise trillions and would take atleast 10-20 years to mature.