Chinese ‘mini-stimulus package’ may be coming: ex-PBOC adviser

29 Aug 2015 | Author: | No comments yet »

Former PBOC Adviser Li Says China Growth Still on Target for 7%.

Money is flowing out of China at a quickening pace, leading to Beijing selling currency reserves in what amounts to a global quantitative tightening.Absent loosening elsewhere, conditions for riskier assets, and for global growth, will get tougher.The People’s Bank of China piled up nearly $4 trillion of foreign assets in the decade from 2003 as dollars flowed in from trade and were invested in securities such as US Treasuries in order to keep the yuan from strengthening.

There is sometimes a feeling that “the markets” are a kind of all-knowing beast, with trading based on forensic analysis of the latest economic and business signals.Violent market swings sent the S&P 500 into correction territory over a four-day period that began last Friday, while other markets around the world fared just as badly.

Now the money is going the other way, a trend which accelerated after China experimented with a devaluation and a new semi-flotation of its yuan.Whereas China had been spending down its reserves at a more than $500 billion annual clip in July, conflicting reports suggest the PBoC may have spent between $100 billion and 200 billion since the Aug. 11 currency regime shift. “The PBoC has been defending the renminbi, selling FX reserves and reducing its ownership of global fixed income assets. A goal for economic growth of 7 percent “is still in my view what policy makers will and should aim for,” Li Daokui, a professor at Tsinghua University, said in a luncheon address on Friday at the Kansas City Federal Reserve’s policy conference in Jackson Hole, Wyoming. The PBoC’s actions are equivalent to an unwind of QE, or in other words Quantitative Tightening,” Deutsche Bank strategist George Saravelos wrote in a note to clients.Remember that the assets bought up and stashed away by the PBOC were larger than all of the Federal Reserve’s QE efforts combined. That is the only way to explain the extraordinary ups and downs, with reporters on the trading floor in New York saying they had experienced some of the strangest days they had seen in decades.

Li said Chinese officials have room to further cut interest rates and lower required reserve ratios for banks in an effort to boost lending and the economy. The PBOC cut its one-year lending rate this week by 25 basis points to 4.6 percent and lowered banks’ reserve-requirement ratio by 50 basis points to 18 percent. “Some people argue the natural rate of growth will come down to lower than 6 percent,” largely because of a growing shortage of labor, he said. “I do not fully agree with this analysis,” because it doesn’t take into account that workers will gain skills and education, making them more productive. China is, after all, now the world’s second-largest economy, and, although direct trade links to it from many economies remain limited enough, a hard landing in China would shake the world.

In the last 25 years, the Shanghai Composite, China’s benchmark stock index, has closed within one percentage point of the previous day’s close on just 56% of all trading days, with an average movement of 0.09% (see chart). Weak demand at Treasury auctions Tuesday and Wednesday were marked by weak demand from ‘indirect bidders’, a category into which foreign central banks fall.As well, Treasury prices haven’t moved as they usually would during signs of financial stress. For the moment this looks unlikely, with the Chinese economy more likely to slow to a growth rate of about 5 per cent this year than suffer some kind of collapse. Despite their safe asset status, 10-year Treasury yields, now around 2.17 percent, are actually up by four basis points, with prices moving down, since China’s currency shift Aug. 11. However, none of the factors that drove investors to sell have gone away, so there will likely be more volatility and weakness in the weeks and months ahead.

Outbound money is partly direct and indirect investment flows, and partly money controlled by private Chinese citizens seeking a safe haven, both from more difficult financial conditions at home and also from the threat of seizure via official action. The US central bank, the Federal Reserve, had been expected to lead the way by increasing its key interest rate from effectively zero to 0.25 per cent in September. Judging by the market’s historic volatility, the 8.5% sell-off on Monday was indeed an extreme anomaly, with the daily return falling more than three standard deviations away from the average—a so-called “three sigma” event.

As Gluskin Sheff + Associates Inc. chief economist and strategist David Rosenberg pointed out, it’s understandable that markets see China’s economy as being in worse shape than anyone anticipated given that Beijing devalued its currency for the first time since 1994. At the same time, the heavy-handed but ineffectual support of the stock market managed to inspire fear, with arrests of short-sellers and a financial journalist, but not confidence in official control. Indeed, the FTSE 100’s 4.7% drop on Monday, at 4.2 standard deviations from its average return, was a bigger outlier (about 1 in 10,000) than China’s market decline, at 3.2 standard deviations (5 in 10,000).

But China’s actions raise the possibility that rather than being influenced by economic considerations, it is increasingly being driven by what financial markets want. China’s reserve stockpile is well above what the IMF recommends in similar situations, if we define China as having, more or less, a fixed currency with no capital controls.“In a nutshell, the PBoC’s war chest is sizeable, no doubt, but not unlimited. And, in this case, investors should be careful what they wish for. “So China is the second largest economy in the world,” Rosenberg said. “From 1968 to 2010, it was Japan and somehow, we all managed to survive its frequent dives into recession over the past quarter century.” Chinese authorities could have more surprises in store for the markets, but before then, investors will probably be more concerned about picking through Fed vice-chair Stanley Fischer’s speech on Saturday at the annual Jackson Hole, Wyo., conference for clues on interest rate policy.

Emerging market hit: The fallout from China’s slowdown has hit other so-called emerging markets – developing economies generally in Latin America, Asia and Africa – in a number of ways. Most obviously the falling demand from China for commodities such as iron and other minerals has hit the big exporters of these products – everywhere from Brazil and Mexico to Malaysia and even Australia. The final complication is the risk that rising US interest rates pull investment out of these countries and back to the US, where the return will slowly increase. The reality may well be that after more than a decade of attracting capital flows and stimulating global financial conditions, China, along with the rest of the world, may see a long period of the reverse.Rather than a bubble popping, the correct metaphor may be a long, slow deflation.

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