People’s Bank of China

The risk of a large devaluation in the Chinese renminbi is once again spooking markets, which are firmly convinced that this as a very bad contingency for global risk assets in 2016. As last year ended, investors became more relaxed about the threat, following a series of veiled announcements from the PBoC about its currency strategy. These statements seemed to suggest that the central bank would broadly stabilise the effective exchange rate against a currency basket from now on, while allowing greater flexibility against a (possibly) rising dollar.

Since the dawn of the new year, however, investors have become much more concerned that a larger devaluation may be in the works, either through the choice of the Chinese authorities, or because the outflow of private capital is getting out of hand. Some bears in the currency markets believe that China could soon be suffering from a genuine exchange rate crisis, in which its enormous foreign exchange reserves could be quickly drained.

That would indeed be a severe shock to global markets, since it would effectively export the deflationary forces that are overpowering the Chinese manufacturing sector to the rest of the world, and would probably require direct measures to restore the health of the Chinese financial system. But it still seems unlikely to happen, for now at least. Read more

There has been a significant weakening in China’s exchange rate in recent days. Although the spot rate against the dollar has moved by only about 1.3 per cent, this is actually a large move by the standards of this managed exchange rate. Furthermore, the move is in the opposite direction to the strengthening trend seen in the exchange rate over the past three years.

This has triggered some pain among investors holding long renminbi “carry” trades, along with much debate in the foreign exchange market about what the Chinese authorities are planning to do next. Since China does not explain its internal or external monetary policy in a transparent manner that is intelligible to outsiders, there is much scope for misunderstanding its true intentions. The key question is whether the Chinese authorities are changing their commitment to a strong exchange rate and, if so, why? Read more

International investors often complain that they have a hard time understanding the actions of the People’s Bank of China. The PBOC still seems to pride itself on the inscrutable nature of its policy pronouncements, rather in the style of the Fed until the mid 1990s. In order to judge what the Chinese monetary authorities are doing, it is necessary to watch their actions more than their words, and even then there is plenty of room for misinterpretation. As in other areas of Chinese public administration, power resides in secrecy.

The fact that Chinese monetary policy can seem obscure to outside observers does nothing to diminish its importance. In fact, the ongoing attempt to deflate the 2010-13 credit bubble in China is more important for the global economy than the Fed’s tapering plan, or the ECB’s thinking on negative deposit rates. A collision is developing between a progressive tightening in monetary conditions, and the inflationary psychology of the housing and land markets. No-one can be certain how this will end. Read more