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From China: Dollar, Deflation, And The RRRest

Summary:
It’s not necessarily a discrepancy so much as maybe looking at the same thing from a different point of view. China’s State Administration of Foreign Exchange (SAFE) reports on, among other things, the widest definition of foreign assets being under its whole national umbrella. Yet, the agency publishes balances denominated not in CNY, either US$’s or SDR’s (hey, they can dream!) instead. The country’s central bank, the People’s Bank of China (PROC), owns, holds, and manages (a comprehensive term of art) a big chunk of those reserves. In fact, contrary to what seems popular perception, these foreign assets (largely US$ denominated) form the basis of the Chinese domestic monetary system (RMB). Because of this fact, China really, really needs dollars (see: below).SAFE indicated that during

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It’s not necessarily a discrepancy so much as maybe looking at the same thing from a different point of view. China’s State Administration of Foreign Exchange (SAFE) reports on, among other things, the widest definition of foreign assets being under its whole national umbrella. Yet, the agency publishes balances denominated not in CNY, either US$’s or SDR’s (hey, they can dream!) instead.

The country’s central bank, the People’s Bank of China (PROC), owns, holds, and manages (a comprehensive term of art) a big chunk of those reserves. In fact, contrary to what seems popular perception, these foreign assets (largely US$ denominated) form the basis of the Chinese domestic monetary system (RMB).

Because of this fact, China really, really needs dollars (see: below).

From China: Dollar, Deflation, And The RRRestFrom China: Dollar, Deflation, And The RRRest
SAFE indicated that during the last half of 2020 a small few might have trickled in – alarmingly, though, in the same way and at close to the same suspiciously low rate as had been experienced in 2017. Since the end of last year, though, sideways; no more than December.

In reporting in US$ valuations, however, SAFE’s total is influenced to some degree by the market value of all those foreign instruments. As the media kept reminding everyone, there was that “historic” selloff in many if not the vast majority of those (foreign reserves are most often held in the form of foreign government debt like UST’s). Meaning, there still might have been a trickle of inflows into China that had been reinvested in UST’s and the like which then declined in value.
From China: Dollar, Deflation, And The RRRest

The PBOC, on the other hand, is openly trolling at this point (see: above). For several years, China’s central bank had clearly engineered (through various likely nefarious unknown perhaps unknowable means) a targeted range (and a very narrow one) for its foreign reserve balance sheet basis. Such absurdity was taken to ridiculous heights beginning in August 2019 (a very strong clue) and lasting all the way to the end of 2020.

For the month of February 2021, the PBOC said it had finally gained some inflows; the central bank reported the highest level of foreign reserves on its balance sheet since August 2018. Hurray, reflation! This anodyne description makes it sound consistent with the narrative as well as what was then running global bond markets during that month (though somewhat inconsistent with the behavior in CNY; another clue).

Technically true, though the rise in reported foreign assets was the equivalent of a rounding error and not really anything like actual reflationary inflows.

Not to be outdone, for the month of June 2021 yet another of the same. Following March, April, and May when foreign reserves didn’t move at all in either direction (again, the obviousness of targets/engineering), suddenly the PBOC reports the highest level of foreign reserves since January 2018. Another milestone comeback!

Once more, technically true yet almost surely purposefully empty. For anyone paying attention (which, Chinese authorities know, won’t be many), the question is why go through such a patently obvious charade?

The answer, I believe, was given to us this month, the one immediately following this latest chapter in the ongoing make-believe. Suddenly, July 2021, RRR cut.
From China: Dollar, Deflation, And The RRRest

The RRR (as noted in some detail here with relevant background) shares a causal space with not just Chinese monetary policy but more importantly eurodollars as they are rather than eurodollars as the PBOC pretends to present them back to the world. For one thing, there’s the potential discrepancy between its own published figures and those from SAFE. Maybe that’s just US$ values, or there were small inflows for the PBOC which were washed out by small but slightly larger outflows at some other agency, still none of this adds up to what it is “supposed” to.

And what is supposed to be happening is actual, legit reflationary inflows. Like 2017, this dancing around in minute quantities obscures a very different reality which is quite missing in real dollars. Where the hell are they?

Unable to present an answer to that frank question, you can, I hope, appreciate the monetary dilemma for China.

Furthermore, if you know, as a Chinese monetary authority, that you’ve been playing a game before then suddenly suspecting you won’t be able to play the same way much longer, then this external make-believe shortly becomes an internal monetary contraction issue and thus the RRR. The same type of policy choice (or lack thereof) practiced in only the worst eurodollar, global economy circumstances.
From China: Dollar, Deflation, And The RRRest From China: Dollar, Deflation, And The RRRest

It’s not like we haven’t seen this kind of thing unravel before. We need go back only a few years, to 2018, when reflation and inflation had likewise been accepted by the masses (the public doesn’t know any better thanks to Economics being so wrong about money, leaving people all over the world in a perpetual a state of illiteracy) only to have been undermined the entire time in effective (euro)dollars.

Once that farce became untenable, around January/February 2018, it was only a matter of time before it quickly unwound – CNY fell sharply as the actual dollar shortage “outflows” rather than reflation inflows left it in a precarious situation not just externally here but also internally with respect to RMB. The RRR cuts quickly manifested beginning in April 2018 (more would follow).
From China: Dollar, Deflation, And The RRRest

CNY in 2021 has been acting rather un-reflation, too; no longer so easily “strong”, meaning moving upward against the dollar, but more rolling over in much the same way (though taking longer this time) as it had in those early months of 2018.

And now one RRR.

So far as the rest of the PBOC’s balance sheet is concerned, there is pretty good reason for any rising negative and deflationary potential. No matter how poorly China’s economy has performed (every honest bit of data analysis indicates conclusively that it has, in fact, performed exceptionally poorly) real money monetary policy refused to budge. As you might surmise, I don’t count RRR adjustments as real money policy (for consistently good and recently historic reasons).

From China: Dollar, Deflation, And The RRRest From China: Dollar, Deflation, And The RRRest From China: Dollar, Deflation, And The RRRest

In other words, currency growth of 4.9% year-over-year in June was half of the emergency rate of 2020 (which itself had been half the rate of what used to be normal) and pretty much the same low level as had been the forced on China during those other bad years of RRR cuts and PBOC eurodollar problems.

Bank reserves are up compared to 2020, but only by a few percent even after several years of declines leading up to 2020 and that whole huge recession last year. Since the end of last year, though, like the downshift in currency growth, bank reserve growth has also downshifted to about zero in 2021.

From China: Dollar, Deflation, And The RRRest From China: Dollar, Deflation, And The RRRest

So, what does all this really mean?

A ton of reasons, consistent and universally coherent reasons, to be betting global deflationary where China’s economy, its government stance on that economy, and, behind both, the actual state of the eurodollar are all concerned. Pretty much everything that’s important. And, as noted, we’ve seen this before not all that long ago.

No one remembers even a few years ago because no one was really paying attention, or knew they should pay attention, the last time (or the time before; etc.) Therefore, deflationary bond markets worldwide are some big mystery when for the public and the media when, in truth, the answers are all on the PBOC’s balance sheet. Even its inconsistencies are evidence.




Jeffrey P. Snider
As Head of Global Investment Research for Alhambra Investment Partners, Jeff spearheads the investment research efforts while providing close contact to Alhambra’s client base. His company is a global investment adviser, hence potential Swiss clients should not hesitate to contact AIP

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