Flyover Country : 2018-10-07

Down goes the renminbi. The redback fell by a hearty 0.8% during today’s Asian session to close at 6.926 per dollar, the weakest finish since March 2017. The renminbi’s latest leg lower follows a 100 basis point cut to the reserve ratio requirement of Chinese banks, a move which frees up RMB 750 billion ($109 billion) in liquidity.

Could the yuan trade above seven per greenback? Ken Peng, strategist at Citi Private Bank in Hong Kong, tells Bloomberg that “the RRR cut sends a strong signal that China is in an easing cycle and all external news makes the case for a stronger dollar.”

Of course, the Sino-American trade dispute figures prominently in any assessment of current conditions in the Middle Kingdom. In a meeting today with U.S. Secretary of State Mike Pompeo, foreign minister Wang Yi told the diplomat that the U.S. hard line on trade has “directly impacted our mutual trust and cast a shadow over our bilateral relations.” On Friday, data from the U.S. Census Bureau found that China imported no U.S. crude oil in August, down from just under 12 million barrels in July and the first such whiff since September 2016.

As Beijing grapples with the Trump administration, some economic indicators suggest mounting troubles in the world’s second-largest economy. The pronounced weakness in Chinese equities continues apace, with the Shanghai Composite Index sinking by nearly 4% today to extend its year-to-date loss to 18%. The weaker renminbi has likewise corresponded with a hint of capital flight, as FX reserves declined by $22.69 billion in September, the biggest drop in seven months.

Meanwhile, growth in credit and in the money supply are both slowing. According to the People’s Bank of China, the net change in aggregate financing totaled RMB 12.2 trillion ($1.7 trillion) through August, down 13% year-over-year. Chinese M2 growth likewise reached 8% year-over-year in June, the lowest in at least 20 years, and remains near that nadir.

Then there’s the property market. A Bloomberg dispatch from today details a less-than idyllic scene which unfolded during the just-completed Golden Week holiday:

A sales center for Xinzhou Mansion, a project of Country Garden Holdings Co. located in Shangrao, a city in Jiangxi province, was mobbed last Thursday, videos and pictures on social media show, its windows smashed by scores of protestors throwing rocks. They’re furious that Country Garden is selling units for prices around 30% lower than a year ago.

Also last week, Country Garden peer China Vanke Group Co. Ltd. announced a roughly 50% price cut to new townhouses in the city of Xiamen, according to an Oct. 2 report by the Epoch Times. The homebuilder, founded in 1984, is girding for a rough road ahead. According to Chinese publication The Paper, the theme of Vanke’s fall conference in Shenzen was “survival.”

With credit growth on the wane and the lynchpin property sector coming under (at least anecdotal) pressure, how might the government respond? Market manipulation, naturally. In an Oct. 1 commentary, Anne Stevenson-Yang of J Capital Research notes the extent of the Chinese government’s grip (and economy’s reliance) on house prices, while offering an ominous assessment of a broad downturn’s potential impact:

The whole Chinese economy surfs atop property speculation, and values of residential real estate, although in vast oversupply, have lofted higher year after year, often in double digits . . . What sustains high residential property prices, at current exchange rates exceeding most of the toniest cities in the world, is not an excess of demand over supply. It is rather a unique combination of Chinese features, including the state ownership of land and the local government allocation of it, local government dependence on rising land values, local government involvement in building materials and construction, and local controls over postable land values and sale prices. Taken together, these interventions have jacked up property prices to levels far, far beyond what any natural market would support. If real market transactions ever took control of property prices, there would be a devastating reset.

Seemingly, everyone understands that when property prices crater, that is when debt throughout the economy becomes unsupportable. Inflated property prices are the core asset base of a vast chunk of bank assets. The task for China’s government is to freeze up the markets transactions in order to trap current artificial values in property, thus making sure that consumer feel rich on paper without actually being able to pull cash out of the market. That will enable banks to maintain the high book value of property that collateralizes their loan books.

So, then, Harry Potter to the rescue?