Grant's Almost Daily Interest Rate Observer

China Reels, Opens Credit Spigots to Survive Trump Trade Sanctions

Deleveraging, we hardly knew ye.  As the Sino-American trade spat continues to hot up, Beijing has responded by further cranking the credit spigots open.  

On Monday, the People’s Bank of China unleashed a record Rmb 502 billion ($72 billion) injection of medium-term lending facility funds to commercial banks, a move, the Financial Times notes, that served to expand the money supply as “no previously issued loans were scheduled to mature” on that day. On Wednesday, Bloomberg reported that the PBoC alerted certain Chinese banks that a “structural parameter” of capital requirements will be cut by 50 basis points in order “to support local financial institutions in meeting credit demand effectively.”  China’s central bank has already cut its reserve ratio requirement for banks on three separate occasions this year.

State support for the economy has spilled into the fiscal realm as well as monetary: Today, Reuters reports that China “plans to put more money into infrastructure projects and ease borrowing curbs on local governments to help soften the blow” from the trade war.

The exertions have already made an impact: On Tuesday, the China Foreign Exchange Trade System reported record volume of repurchase agreements, as “bond traders have taken the slew of credit-boosting measures unveiled in the past week as a green light to borrow.”  Not just in heightened activity are the looser policies being felt. The iBoxx China High Yield Total Return Index, which lost nearly 8% from January to mid-July in a slow grind lower, has promptly recouped half of that downdraft in less than two weeks.

Currency depreciation is likewise accelerating, as the yuan today completed a seventh straight weekly decline against the dollar. Since April, the renminbi has depreciated by 8% against the dollar, a 25% annualized pace. Since July 9, redbacks are down by 3% against the buck, a 44% annualized clip.

Is the weakening currency part of a Communist party plan or the result of rapid capital outflows? Brad Setser, senior fellow for international economics at the Council of Foreign Relations, thinks the former. In a July 23 blog post, Setser argues that the renminbi’s decline, if not an outright policy maneuver by the Chinese authorities, is broadly in line with their strategic interests. Noting a rising “basic balance” (the current account plus foreign direct investment) in China, Setser concludes:

That suggests, at least [to] me, that if China clearly signaled that it didn’t want the yuan to depreciate further, it could hold the line relatively easily. . . The depreciation pressure right now stems, in large part, from expectations that China wants a weaker currency in response to Trump’s tariffs and a slowing domestic economy – not uncontrolled outflow pressure. 

Anne Stevenson-Yang, co-founder of J Capital Research and friend of Grant’s, has a somewhat different perspective. In a July 23 research note, Stevenson-Yang suggests that China’s credit-saturated economy (bank assets topped last year’s GDP by more than 300% and represent more than half of 2017 world GDP) is the primary force behind the recent gyrations in FX, while also arguing that the powers-that-be might ultimately hold less sway on the exchange rate than is widely believed:

The reality is that China’s currency is most intimately connected, as with any currency, to the domestic economy – debt, asset prices, real estate prices, and efficiency gains and losses rather than just trade. On that basis, this is the time for depreciation.

On the one side, Beijing faces very low growth outside of that driven mechanically by lending. Public confidence is low, and families that have wealth trapped in illiquid property are growing restive. People of means want to move abroad and want to externalize their assets. On the other side, Beijing has capital controls.

We are betting the people win.

If the yuan continues its powerwalk lower, the financial stability that Beijing covets could be put to the test. Today, Paola Subacchi of the South China Morning Post declared that the Middle Kingdom is “stuck between a rock and a hard place,” as monetary and fiscal easing designed to shoulder China’s massive debt burden stokes the risk of ongoing currency depreciation, capital flight and a potential drawdown of foreign currency reserves.

Watch the renminbi.