Falling Exchange Rates And Forex Reserves Are A Bad Combination For China
Douglas Bulloch , CONTRIBUTOR
I write about the political economy of China and its major industries
Opinions expressed by Forbes Contributors are their own.
While the world’s attention focuses on the US election this week, it is worth also keeping half an eye on the US dollar / Chinese renminbi exchange rate.
Almost on cue, the PBoC set the Yuan’s mid range against the US dollar at 6.7725 at market opening on Monday 7th November, up from 6.7514.
The traded rate had been getting a little stronger since October 28th from a low of 6.79, but it is now falling again as the US dollar strengthens.
The reason for this strengthening is to be found on the other side of the Pacific, as this most unpredictable election cycle draws to a close. While uncertainty still clouds the outcome, on Friday the 4th of November, the Director of the FBI announced that a recently re-opened investigation into Clinton’s use of emails had now closed again, steadying nerves in the market and pushing up the dollar, which had been reacting negatively to surging support for Donald Trump.
Most of the polling evidence currently predicts a narrow Clinton victory, but if this changes, particularly if the early results are better than expected for Trump, expect fireworks. But do not expect the PBoC to weaken the mid-range trading band, for Goldman Sachs has just come out with some research revealing what most market watchers already knew, that the US dollar/renminbi exchange rate has a ‘meaningful asymmetry‘.
What this means is the that as the US dollar strengthens, the renminbi weakens, yet when the dollar weakens, the RMB does not strengthen, which explains why the USD/RMB has fallen from about 6.5 in March, to nearly 6.8 now, despite repeated statements from Chinese officials that they see no basis for persistent devaluation of the Yuan.
Bloomberg even produced an artful chart plotting the persistent devaluation of the Yuan and marking the points at which PBoC officials have declared the now familiar ‘no basis’ claim.
In March this year I wrote an article noting that the rapid decline of China’s forex reserves was inconsistent with its aspiration for a stable exchange rate. Inevitably, the slow decline in the exchange rate since then was accompanied by apparently stabilised forex reserves.
As you can see, at the beginning of the year, there were large falls in China’s Forex reserves, which stabilised when the RMB exchange rate began to decline. Now, unfortunately, while the RMB depreciation seems to be accelerating, forex reserves are declining again.
At the beginning of the year, however, the two trends moved in opposition to one another - declining forex reserves matching a rising exchange rate – now they seem be moving together. In worse news, it seems that the prospect of exchange rate decline is itself accelerating the forex reserves decline, which indicates the PBoC may be losing the ability to to ensure a stable exchange rate, irrespective of its repeated announcements to that effect.
Things may not be as dramatic as all that if valuation effects are behind the decline in forex reserves, rather than PBoC intervention, but October has certainly witnessed a significant shift towards pessimism that China is on the right path.
The Wall Street Journal, for example now talks of a ‘risky feedback loop between Yuan depreciation and capital outflows,’ and the departure this week of the reform minded Lou Jiwei – to be replaced as Finance Minister by the ex-head of the State Tax Bureau, Xiao Jie – reinforces the perception that China is changing direction, and not necessarily for the better.
And what better time to change direction than when the world is focussed on the US election? Particularly given that attention will quickly return to the US China relationship whichever way it goes. In either event, the relationship between China’s falling exchange rate and diminishing forex reserves will continue to be a headache for the PBoC.