Zhou Xiaochuan, PBoC governor © Getty Images
The long and detailed interview given by the People’s Bank of China governor, Zhou Xiaochuan, to Caixin Weekly on Tuesday is in one sense very un-Chinese. It provides a much more fulsome statement of foreign exchange policy, as viewed from the central bank, than anything available in the past. After months in which the governor has been conspicuously absent from the public fray, he has now chosen to go on the attack.
Mr Zhou sees the recent exchange rate crisis as out of line with economic fundamentals in China, and for that reason essentially temporary. He describes a new currency regime that is best characterised as a dirty floating regime, measured against the renminbi basket, not the dollar. “Speculative” attacks on that regime will be opposed and defeated by the central bank. In the longer term, the peg against the basket can be adjusted if fundamentals change, and the links between the two will be explained in more detail in the future.
This statement will further reduce the risk of a competitive devaluation of the renminbi in the near term. But does that mean that the China currency crisis is over? Read more
It would be tempting to ascribe the large drop in global risk assets last week to the onset of Federal Reserve tightening and a further meltdown in commodity prices. No doubt these factors played a part, but the dominant force was probably the same one that shook the markets in August – the fear of a sudden devaluation of the Chinese renminbi. This would export deflationary forces from China’s industrial sector to the rest of the world, and would interact very badly with the start of a monetary tightening cycle in the US. Read more
The extreme turbulence of the financial markets in August resulted in a temporary rise in the Vix measure of US equity market volatility to levels that have been exceeded on only a few occasions since 2008. Markets have now settled down somewhat, but it is far from clear whether the episode is over. In order to reach a judgment on this, we need to form a view on what caused the crisis in the first place.
The obvious answer is “China”. The response of the Chinese authorities to the stock market bubble, and the manner in which the devaluation of the renminbi was handled, raised questions about policy credibility that added to ongoing concerns about hard landing risk in the economy. The conclusion that a China demand shock was the main driving force behind the global financial turbulence was given added credence by the simultaneous collapse in commodity prices, and in exports from many emerging economies linked to China.
It would be absurd to deny that China had an important role in the crisis of August 2015. But was it the only factor involved? After all, China’s growth rate does not seem to have slowed very much. Furthermore, standard econometric simulations of the impact of a China demand shock on the major developed economies suggest that the effects should not be very large, and certainly not large enough to explain the scale of the decline in global equity prices, or in the “break-even” inflation rates built into US and European bond markets.
It is conceivable that bad news from China triggered a sudden rise in risk aversion among global investors that exacerbated the shock itself. It also possible that markets were responding to the fact that the Federal Reserve apparently remained determined to raise US interest rates before year end, regardless of the new deflationary forces that were being triggered by events in China.
New econometric work published today by my colleagues at Fulcrum suggest that the perception of an adverse monetary policy shock may have been important in explaining the financial turbulence, in which case the Fed needs to tread extremely carefully as it approaches lift-off for US rates. Read more
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The wild events in the Chinese domestic stock market in recent days have shown signs of broadening to other financial markets. Weakness in metal and oil prices, and in commodity currencies such as the Australian and New Zealand dollars, are normally reliable indicators that China is a growing global concern.
But this is more surprising on this occasion, because recent activity data suggest that the hard landing risk in China’s economy has abated. Investors have clearly become concerned that the iron control normally exerted by the Chinese authorities over the financial system is wobbling.
Both Paul Krugman and John Cochrane, from very different analytical positions, have argued that government intervention in stock markets is unlikely to succeed. In any rational world, this would be a far bigger threat to global financial stability than the Greek crisis. Yet investors with long memories will recall that a dramatic intervention in the stock market by the Hong Kong Monetary Authority in August 1998 forcefully reversed the bear market in the Hang Seng index, despite being ridiculed at the time by almost all “informed” international financial opinion.
This intervention severely damaged many macro investors and effectively marked the end of the Asian financial crisis, though the Russian crisis was still to come. 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