Finally, China’s Alan Greenspan Speaks Out

Submitted by PandaHedge

Finally, China’s Alan Greenspan speaks out

Finally, China’s Alan Greenspan, Mr. Zhou Xiaochuan speaks out in an interview with Caixin Magzine.  The market has been waiting for his comment on Yuan since the RMB exchange rate reform in Aug 2015.  However, he has been hiding and did not “give a clear message” as asked by IMF chief Lagarde.  Just before the lunar new year holiday, even the Chinese local media started to ask him to show up, which is really unusual in China.  And last Friday, Caixin published its 12000 words interview with Mr. Zhou Xiaochuan.  This is the most important interview for China’s economy and Yuan in 2016.  I translate the key Q&A points as below and add my comment in blue:

• How do you see China’s GDP slowing and hard landing potential?

1. In 2009 and 2010, China contributes more than 50% of global GDP growth while its GDP only accounts for less than 10% of global GDP. We must realize that’s unusual situation in an unusual period of time.  Now China still contributes around 25% of global GDP growth, so it’s unfair to say China is hard landing;
2. A country’s currency has no strong relationship with the GDP or GDP growth. Actually current account is the most important factor, and China still has high current account surplus in 2015 (goods trades surplus stands at record high $600B).  In addition, China’s CPI is only 1.4%, which is good for stable exchange rate

• Which international factors are important to RMB exchange rate?

1. Yuan has been following US dollar to appreciate with other currencies (such as Euro and Yen) in the last two years. The market believes Yuan has to “catch up with other currencies” to depreciate.

On surface it’s a USD appreciation story, but the reality is ECB and BOJ’s “currency war”.  The downside potential for Yuan would be much lower in USD terms if DXY starts to depreciate, as the Fed may have to cut the rate and even pushes for QE4.  That’s one of the reasons why I don’t buy in the “big collapse of Yuan” argument.  Yuan will depreciate over time but not act like a collapse.

2.The change of US Fed’s policy in 2013 and 2014 has made huge impact to other EM countries but not too much impact to China. However, the Fed’s interest raise in Dec 2015 is a huge shock to China.

Since Bernanke announced the end of QE3, USD’s negative impact to RMB already started.  PBOC underestimated the power of USD’s appreciation (or how “easy” are ECB and BOJ).  But now, PBOC implies that Fed’s raise is “policy error” and it would not tolerate a further appreciation of USD.

3. There are a lot of speculative funds shorting China recently. As the central bank of China, we have confidence of China’s economy, but we also need patience as we have to wait for the data speaking for themselves continuously.  However, for those speculative funds who already made the bet, they are trying to make profit as soon as possible, and that’s why they spread out rumors and create noises in the market.

Yes, that’s how the “$200B decline of foreign reserve in Jan 2016” rumor begins.  PBOC has come out an approach to fight with those speculative funds: increase the volatility of CNH and CNY to increase short sellers’ cost. 

4. Since 2008, global central banks have adopted easing monetary policies which have boost asset bubbles around the world. The asset price need to adjust, and the process is painful.  Everyone tries to find someone to blame for, and they pick China as the unlucky one.

Chinese government and PBOC are already sick of being accused because everyone points China as the major reason of global sluggish growth.    

5. In general, when people analyze the depreciation of RMB to USD, they should consider the appreciation of USD to other currencies and short term market sentiment. People may worry that China will join the “currency war” to improve export.  However, as the net export already contribute a significant part to GDP, we don’t need to depreciate RMB to boost export.  In addition, China imports more commodity in terms of volume (although the value drops because of lower prices), so it’s unfair to say the commodity bear market is driven by lower China demand.

PBOC tries to avoid using the word “currency war”.  However, as the world’s NO.2 economy, it’s inevitable that RMB will have impact to other countries’ economy.  PBOC should consider Yuan’s future with a global view as the value of currency is the power balance between countries.

• Does PBOC has estimation of the size of “hot money”

1. There’s no clear definition of “hot money”. The speculative money (aka hot money) is not the major force to impact the balance of payment.  The major speculative money plays their games in the offshore market, but their behavior will have negative influence on the onshore market sentiment;
2. Export companies are influenced by this kind of depreciation expectation, and thus adjust their FX strategy and operation (such as buying foreign currencies in advance). However, as they eventually need to pay the expense and cost through Yuan, this kind of adjustment will end pretty soon.
3. Local Chinese companies may adjust their foreign debt with the depreciation expectation. Their foreign debt balance is around USD 800B at the end of 2014.  Right now it’s easy for them to get cheap RMB debt to replace the foreign debt, and it’s their own decision to make it or not.  This kind of adjustment will see a bottom soon.

There are three reasons behind the capital outflow since 2014:  a. domestic corporates and residences increase holding of foreign assets; b. corporates pay down USD debt; c. speculative funds.   The major reason is the first one, so it’s “internal problem”.  PBOC is comfortable to let Chinese residences to keep foreign currencies on their hands, just like China let residences hold gold by themselves.  PBOC seems confident that corporate and individuals will adjust their behavior when the Yuan return to relatively stable stage. 

• Will PBOC reinforce capital control?

1. We hope the process of RMB internationalization will move smoothly. However, it is a back and forth process in reality.  When the speculative funds become a major issue and the FX is volatile, we may hold off the internationalization process and focus our power to handle them.  When the FX markets come back to stable stage, then we will continue to push the internationalization of RMB.

This is PBOC’s bottom line.  To protect the domestic economy, it’s possible to delay the process   of RMB internationalization.   For example, PBOC may delay loosening its capital account.  I believe it’s an appropriate approach after we see the incompetent policies in A share market pushed by China’s financial officials.  It’s hard to believe these officials have ability to control a potential currency chaos after the capital account is opened, especially when China’s economy still would experience restructuring in the next couple year.  The right way is to set up a more comprehensive financial system and resolve China’s own economy problems (such as overcapacity and overleveraged) before PBOC let Yuan become a free circulated currency  

2. We have tightened the control of foreign currency exchange with the aim to ban the illegal fund transfers such as money laundering and fake merchandise trades. For legal and normal request of currency exchange, we always will meet their needs.

PBOC is not stupid.  The biggest power to consume China’s foreign reserve is the domestic corporations and residences.  If PBOC bans their normal needs of foreign currencies, they will have stronger depreciation expectation and accelerate the pace of capital outflow

3. Financial market is different than the real economy, as confidence plays a very important role in the former one. Speculative funds spread rumors to help their trade.  For example, there’s rumor that the foreign companies cannot transfer their earning out of China.  It’s actually a current account item but not a capital account item, so there’s no way SAFE will block this kind of action.  Even for capital account items, companies are able to get foreign exchange as long as they follow the rules.

Honestly, I don’t think any hedge funds in the world has the power to fight with PBOC.  The size difference is so huge, and I think the smart hedgies understand this well.  So they leverage market sentiment to put pressure on Yuan.  Actually, the Yuan is not their main battle field.  The size and liquidity of Yuan is so small, and the hedgies are easily squeezed by PBOC.  The smart hedgies actually target other weaker countries who compete with China in the global export market.  As the expectation of Yuan depreciation rises, those competitors’ currencies will see more pressure, and their central banks have much weaker power than PBOC to defend their currencies.  

4. Capital control does not work in an open economy. In addition, it is more effective to control capital inflow rather than capital outflow.  China is a big open economy and relies on international trades more than other major economies.  Every year, China has around $4trn trade transactions which involve more than one million companies.  China also has around 100 million outbound travelers now.  Therefore, any improper capital will have negative impact on confidence and balance of payment.

• Many people have concerns about the decline of foreign reserve. How PBOC views and handles the speculative funds?

1. It’s difficult to differentiate between speculative funds and normal risk management transactions. China has the biggest foreign reserve in the world, and we would not let speculative funds lead the market sentiment.  As long as China’s fundamentals have no big issues, foreign reserve will not be a problem even the balance will vary from time to time.
2. Although we will not let speculative funds lead the market sentiment, it does not mean we will fight with them face to face. We have to consider how to use our reserve more effectively and find a lowest cost approach.  The RMB exchange reform enables us to handle the speculative funds with more flexibility as we do not focus on USD only anymore.

• What will be the direction and pace of RMB exchange rate regime reform going forward?

1. We will continue the RMB exchange rate regime reform in the next five years. The direction is to build an effective floating exchange rate mechanism which is based on market’s supply/demand and refers to a basket of currencies (not only focus on USD).

A reasonable expectation for internationalization of RMB is at least five years.

2.We emphasize the importance of market’s supply and demand of RMB. Although there are some speculative funds participating the FX market, we still need to respect the market.  We don’t have a model to come out a perfect exchange rate for RMB.  We like to keep the RMB in a relatively stable stage which is close to reasonable balanced level

3. Referring to a basket of currencies is an inevitable process to RMB as China has so many trade partners. We did not do a good job before as RMB focus too much on USD.  In the future we will rely more on reference to a basket of currencies. The result of this direction is that RMB will be relatively stable to a basket of currencies but become more volatile to USD.

The market was used to a stable appreciation path of RMB to USD.  PBOC tries to break this kind of expectation and push the volatility higher.  It’s a normal case for major currencies in the world, so I don’t think the market should panic about this.  Higher volatility also means higher cost for short sellers.

• How PBOC can improve its communication with the market?

1. The current financial market has many uncertain factors and participants hope the central banks will come out to comfort them. However, central banks are not God.  Therefore sometimes we have to say: ”wait a minute, we need more data”
2. For forward guidance, we have to consider couple issues: Whether central banks have better information than the market? Whether central banks have a better forecast model than the market?  If central banks themselves cannot align opinions internally, whether the forward guidance really can relive the markets’ concerns?
3. Central banks should have different communication strategies to various market participants. We would not told our action plan to the speculative funds, but we will deliver reasonable expectation to the organizations (such as merchandise traders) which need to use foreign currencies in their normal business transactions.

PBOC should improve its communication to the market. Central bank should work as a manual of economy, and the market can read through the manual to make their own judgement.  The manual should be designed as simple, clear and easy to read, otherwise the market has to guess and may misunderstand central banks.