The Simple Equation
My entire premise was to make this mockingly simple. Econometrics demands mathematical precision yet always comes up empty because its calculations, no matter how elegantly complex, proceed from the falsest of subjective assumptions. It won’t matter how awesome the computing power if the thing you’re trying to compute doesn’t work or act the way you believe (because everyone says so rather than the evidence).
When any currency falls especially against the dollar even today the mainstream convention attributes it to some kind of central banker intent (“devaluation” or its fancier cousin “competitive devaluation”). The mythology behind the Greenspan version of the central bank just won’t die; that if something happens it’s because the all-powerful monetary agency theoretically at the center of every monetary universe wants the thing to happen.
No. The central bankers and the formulas they come up with are along for the ride just like everyone else. Thus, the sarcastically derived: CNY DOWN = BAD.
To begin with, even though CNY is China’s currency it’s not only bad for China but, eventually, it ends up being bad for the entire global economy. If it ends up being more than short run market fluctuations, like 2014 and 2018, then whatever or however “robust” the global economy is being spun at that time you can be assured that even the media cheerleaders won’t be able to keep up the sunny pretense for very long thereafter.
And it has little to do with Chinese authorities insofar as monetary policy – effect, however, is another matter (see: below). In other words, a falling yuan exchange value isn’t really about the PBOC, nor even China’s yuan. Instead, CNY DOWN is all about what must be on the other side driving it in that direction – eurodollar.
If CNY is going down, then eurodollar (and US$ exchange value) is going up and that’s the real wrecking ball; the global dollar shortage which never really leaves the global dollar system is rewarming itself up to some degree. If it’s got enough degrees of illiquid heat to the point that CNY’s being moved in some noticeable fashion, then the simplicity of our own equation only offends the pseudo-precision of econometrics.
CNY DOWN = BAD.
For seven months, the equivalence had been working at its inverse; CNY UP = REFLATION. This had been curiously hollow, at least where it does involve China’s beleaguered, constrained central bank. Like 2017 (your first clue), the reflationary currency direction proved irresistible but for reasons that weren’t plainly evident like they should have been; if reflationary dollars had been flowing in, a great many would end up on the PBOC’s balance sheet.
They didn’t in 2017 (setting up the severe reverse in 2018) nor in 2020. China’s monetary authority instead reported a clearly engineered balance sheet – and not for just some trivial line in its accounting, the very heart of domestic RMB money.
But with CNY now falling further and further by the day in March 2021, piling up the days pointing toward possibly real-deal CNY DOWN, why did the PBOC suddenly report a miniscule rise in forex assets (dollar inflows, presumably) for the month of February? As noted Friday when assessing the key indicating divergence German bunds to UST’s, the increase was incredibly small, absurdly tiny.
In short, there was absolutely no reason for this. After all, for two years the central bank was perfectly happy to report its balance following along a near-straight trajectory. If there were any real dollar inflows in February 2021, they would’ve shown up as more substantial than what can be confused with a rounding error. So, why not continue the same pretend sideways?
To ask the question is to answer it; just as China wanted to report the lack of contraction up to now, the PBOC intended to show a positive number for last month. Given what CNY is now doing, you might therefore understand the (backwards) reasoning. And that includes what else is going on where the central bank’s eurodollar-imposed balance sheet constraints are concerned.
Most of all: currency. The dollar shortage problem and China’s real inability to do much about it has been transformed internally via mostly bank reserves (shrinking with RRR cuts intended to somehow offset this). However, physical currency issue has likewise been constrained and the effects of this may be even more profound – on more than China’s internal economy.
The Chinese New Year’s Golden Week celebrations render monetary comparisons, like economic statistics, between Januarys and Februarys each year a little more complicated. The central bank must increase outstanding RMB in both bank reserves and physical currency to accommodate holiday travel/spending while banks in the country remain closed for an entire week.
If we average the reported balances of January and February together, it does give us an approximate hint of policy demands during holiday periods. Last year, for example, amidst COVID, the PBOC obviously prioritized monetary issue; physical currency on average January-February 2020 was up nearly 8% compared to January-February 2019.
That was the highest cine January-February 2017 when currency was up nearly 12% on growing reflation.
You can see the eurodollar pattern quite clearly in the Golden Week comparisons for physical RMB currency; down moving toward or deeper into Euro$ induced global money shortages, and then up again during reflationary periods.
For 2021, a year presumed to be even better than the reflationary second half of 2020, the average for RMB currency was 1% less than last year.
Like CNY, that’s the wrong direction.
For one thing, if the PBOC may have to worry about the durability of reflation, meaning the expense of maintaining the dollar inflow illusion, and doesn’t want to exacerbate any further downward CNY pressures, the prudent course is (or seems) to over-manage (even more) the liability side in anticipation of perhaps rougher eurodollar conditions to come. Authorities can’t overextend on internal currency (or bank reserves) if the pretend inflows suddenly become very real outflows (again).
They’d have to conserve balance sheet flexibility – like in 2018 – by straddling RMB money growth between bank reserves (possibly counterbalancing with RRR cuts) and physical currency.
In 2021, if there has been a wrinkle, China’s central bank has actually emphasized bank reserves over currency – while the latter shrunk in January-February, the former was up, also on average over the two months, ever so slightly. With prospects for defaults and bank irregularities becoming near regular occurrences, the PBOC apparently decided it would rather attempt to deal with RMB liquidity issues directly (slightly more reserves) rather than indirectly through another RRR.
If this is the actual case, it doesn’t indicate a whole lot of confidence.
And it comes at the cost of currency because the eurodollar constraint remains, and, it appears, the PBOC is looking at less reflationary conditions from which to set future policy positions (thus, CNY DOWN in March). This then could explain why authorities chose the ridiculously tiny, otherwise unnecessary increase in forex reserves for February; to at least publish the biggest plus sign for its own balance sheet forex inflows in two years (technically true, functionally meaningless knowing that the headline would be written just that way anyway) hoping to add some upward CNY influence (obviously not being able to).
Visuals aside, CNY is finishing March 2021 the way RMB currency had already suggested. Like so many other prices/markets around the world, it doesn’t necessarily add up right now to anything more than short run market fluctuations, but the coincidence, timing, and the PBOC’s balance sheet are altogether indicative of more serious potential very much worth keeping a close eye on.
Those probabilities are, again, so simple they don’t need even a calculator. CNY DOWN = BAD.