The Phaserl


On the Road to Panicville

by Pater Tenebrarum, Acting Man:

An Alert for the Global Posse of Liquidity Junkies

In the summer of 2015 and again in December-February this year, global stock markets were rattled by weakness in the yuan’s exchange rate vs. the US dollar. Yuan weakness is widely held to exacerbate pressures on other (already weak) emerging market currencies, but more importantly, it is seen as a symptom of accelerating capital flight from China.

USD-CNY, daily (a rising price denotes yuan weakness) – slowly creeping toward Panicville again? Resistance is between 6.60 and 6.65 – we suspect that if that level is exceeded, all hell could break loose again – click tro enlarge.

Why is it considered important whether or not China’s foreign exchange reserves are increasing or declining? Similar to Japan, China has become a major cog in the global fiat money Ponzi game, in which foreign central banks monetize US treasury bonds by recycling dollar-denominated trade surpluses.

Now, it should be clear that the term “monetization” does not refer to the creation of additional US dollars in this case – those can only be created by the Fed and the US banking system. Rather, foreign CBs are boosting their domestic money supply when they buy dollars from their exporters – since they are paying for these dollars with domestic currency they create out of thin air.

In China the effect of dollar inflows on the domestic money supply is especially pronounced. In fact, in order to stem the pace of money supply and credit growth lest it get out of hand completely, the PBoC has imposed one of the highest minimum reserve requirements in the world and is regularly altering it to influence credit and money supply growth in the country.

By way of the minimum reserve requirement the PBoC intends to at least brake additional growth of the yuan money supply (beyond the growth caused directly by its USD purchases) to some extent, i.e., money supply growth which its fractionally reserved banks are generating by granting ever more inflationary credit.

It should be obvious though that the PBoC has actually remarkably little control over inflationary credit growth through its official “toolkit”, as the effect is only indirect. Luckily (from the perspective of the central planners), it can also simply issue orders to the (largely state-owned) big banks and can by and large be certain that it will be obeyed.

Achilles Heel

Market participants worry though about capital flows. Assorted liquidity junkies rightly see China’s forex reserves as an Achilles heel. The reason is that a decline in these reserves hampers the PBoC’s ability to manipulate money supply growth in an upward direction. This in turn is regarded as very important in order to keep various bubble activities intact – not only in China, but also in the rest of the world, e.g. through the effects China exerts on commodity prices.

China’s narrow money supply M1. This may be one of the world’s most important data points for the global posse of liquidity junkies. As of April 2016, the situation is still fine from their perspective – click tro enlarge.

As we have described in “The Pitfalls of Currency Manipulation”, China’s authorities have recently resorted to all sorts of tricks in order to mask the pace of the outflow of foreign exchange from China – primarily with the help of derivatives transactions (yuan forwards have been employed to surreptitiously support the exchange rate).

Such manipulations tend to work great in the short term, but they are also making devastating calamities in the long term far more likely. But we’re all dead in the long term anyway, so who cares, right?

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