China's Impending Financial Crisis 17 comments
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Sitting here in Hong Kong, I know few people who aren’t transferring money into China to take advantage of the appreciating RMB and attractive domestic rates. In fact, a study conducted by the Chinese Academy of Social Sciences estimates there is around USD1.75trn of such money within China, with USD150bn coming during the first five months of 2008.
The good news for these investors is that the RMB is still expected to appreciate over the next 1 to 2 years as the Chinese government continues to correct economic imbalances. However, there is bad news. Eventually, the RMB appreciation will peak, and those investors solely within the country to take advantage of the appreciating currency will begin to pull back. This will likely cause liquidity problems within the Chinese economy, and will lead to further depreciation as more investors attempt to withdraw their funds. This potential crisis has not gone unnoticed. The branch head of the Jiangsu province China Banking Regulatory Commission released in a paper this week the following comments:
The initial judgment is that China's financial crisis will kick off between 2009 and 2010, though it may be a year or two later, and will be triggered by a turning point in yuan appreciation…
By that time, international capital will flow out instead of coming in and the yuan will face depreciation instead of appreciation pressure. China will face a liquidity shortage and financial crisis will therefore follow.
In fact, when looking at the RMB NDF rates, we can see that the market is currently pricing in a slight RMB depreciation around the 3-year time horizon (see chart below). In fact, back in May we even saw the 1-month contract briefly imply depreciation for the RMB, demonstrating the potential volatility of the market. This notwithstanding, we have begun to see the growth rate of Chinese exports slow, a trend we expect to continue. This coupled with an unwavering demand for imports, will place a stronger weight on the domestic sector to support China’s growth.
To make matters worse for the export sector, the Chinese government has initiated new capital controls to reduce the amount of 'hot money' that may be hidden within the sector (i.e. through over-invoicing). Some estimates have placed the amount of hot money hidden within the sector at around 2% of exports. The good news is that the increased importance of the domestic market within China could cause the government to reduce some restrictions on the sector, meant to reduce over-heating within the economy. Yet, a conundrum could arise if Chinese inflation rates once again begin to accelerate. However, at this point most analysts’ estimates are calling for inflation to slow.
The Current RMB NDF Implied Rates show the RMB Depreciating Slightly in 3 Years
Source: Bloomberg
The bottom line is that China is facing a potential financial crisis that could occur sometime over the next 2 to 4 years. I will continue to look at the RMB NDF market and changes to the government’s foreign exchange policy as potential forward looking indicators to this crisis. In the meantime, the slow-down in Chinese exports will likely have 2 short term effects, 1) a decelerated RMB appreciation, and 2) the potential for authorities to lift some regulations put in place to prevent the domestic economy from overheating. This could have positive effects on the local equity markets, after facing significant losses from their previous highs. In fact, last week we already began to see the local equity markets respond favorably to the possibilities of less stringent economic policies.
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This article has 17 comments:
The RMB forwward market, FX swap markets are essentially closed and controlled by SAFE. SAFE have been closing access to the FX swap markets recently citing 'national security'. In other words they dont want the market pricing these instruments, the Government wants to be able to keep on manipulating the currency and its associated instruments.
Lots of very likely sceanrios could effect the RMB rate very strongly, the forward market does not price in these scenarios as it is lagging due to it essentially being a closed system.
For example it is becoming ever likely that the USD is going to start its next leg of weakness after consolidating for the past few months. We could see a 10% decline very quickly across the board. Especially with the solvency crisis hitting the USA financial institutions and the fact US interest rates are going nowhere this year.
This will have a direct effect on the RMB rate, especially with the Europeans demanding that China takes some of the FX pain that they are taking with the falling of the USD. This will not show up in the forward market until it hits the spot market. Really the spot market is the pricing mechanism for the forward market. Thats the reality.
The Chinese Central Bank is already very worried about high inflation, however I predict shortly that we are going to see a huge uptick in broad based inflation because now all producers are starting to raise their prices in line with the increase of their spiralling costs. Everything is going to go up. EVERYTHING
They will then be left witht he reality that RMB rate is the only way they are going to be able to get inflation under control. The second all the powers at be in China believe that they have an advantage in faster RMB revaluation, the rate will move very quickly in the spot market. This shift in desire can not be predicted far into the future in looking at RMB forward rate. In fact the totally opposite, SAFE will drive the RMB down to flush out speculatiors before any major revaluing upwards. If you watch the market like I do, you will know this happens a lot.
In terms of depreciation caused through otuflows, if the Chinese believe that Money Outflows will put the system at risk when the RMB hits an equilibrium rate. They will simply put in place measures to stop money going out of China. The Chinese really would not think twice about doing this. And believe me it will be a lot harder to get money out of China if they do this than getting it in.
I very strongly believe that if the USA does not have near term plans to convert the USD into the Amero. That they will be looking at a rate of 5rmb - 1 USD in the next two years. Threatening trade embargos if they dont get what they want. Their stance will become ever harder especially as they now realise China is not a friend at the UN table. As soon as Iran/Iraq situation is under control from the view of the US. And the fed have printed enough money to make the financial system solvent again, the USA approach towards China will change drastically. This is the risk I see in the Chinese system going forward.
can you explain how this sentence makes any sense whatsoever, plzthnx.
The picture I get is that there will be major steady rises in all commodities, especially food, and price stagnation in real estate. Already there is major pressure on RE developers in China, who are having to live with increasing interest rates and a public which is becoming more wary about investing in housing in the face of rising prices across the board.
In the face of this, it may even become likely that the Chinese government will come down hard on "speculators" who play the yuan rise. The purpose would be to make an example of them and discourage the practice.
The American investors who have been talked into investing in FXI, (China 25 stock index) will then find their holding severely eroded, following the ^ssec and ^hsi indexes down. Poor things, they just don't have a good place to store their money in a bear market and the talking heads keep giving the wrong advise! A sad situation. Makes you wonder why anyone would invest in China before the Olympics if they could reasonably conclude that the market will be down substantially in the months following the Recession?
China is assendant and can continue increasing their standard of living and global competitiveness for decades. The RNM will follow right along as the government stays fiscally conservative. There are no risk-free investemnts but I just don't see much downside risk for a long-term investor that is long the RNB.
Disclosure: long CYB
JST, RJI, Watg
that the macro regulatory policy should now be shifted from the two preventions of clear signs of inflation and excessive growth TO prevention of inflation and protection of stagflation.
On the above premise, the stock market shall see a clear rebound from the doldrum very soon ,and with that the continued appreciation of RMB as well as inflow of more hot money accelerate
in the months to follow.
To my observation something important would happen before or immediately post Beijing Olympic game ,watch out!Third party observer of China in Malaysia : alwinking@yahoo.co.uk
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