China’s use of FX Reserves Very Worrying

The front page of today’s US print edition of the Wall Street Journal contains an article and graphic that should be cause for concern.  The title of the article is, Yuan Crackdoan Crimps Business.  The graphic in the body of the article shows the quarterly outflows of China’s foreign currency reserve.  The trend line, representing the growth in quarterly outlay used to help ease the fall of the yuan, chiefly against the stronger dollar, is alarming.  Though China has over $3tn of FX reserves, the last reported quarter used up just over $200m Yuan and the trend line would suggest that the next quarter might be close to $250m.  The trend is a straight line no less.

I have called out the recent effort by China’s PBOC to slow the leakage of yuan across its borders.  The article seems to suggest that the PBOC is much more invasive in day to day workings of the banking system to encourage more controls.  Clearly they are concerned.  We should be very concerned.  In fact, the fall in FX reserve (assuming the data is valid in the first place) is as important in the lack of growth in inflation in the US economy – perhaps more so.  As the yuan falls in value, so more and more of the reserve will be used to soften the fall.  But at some point the market will perceive that the reserve is insufficient to stave off a fall.  At that point the market could well attack the currency.  This is akin to what happened some years ago when George Soros and others “broke the bank” of England and forced the pound out of the ERM.  Clearly the scale here is larger, but the importance is greater too.  China is at the heart of our economic growth engine (with the US and India) and if China sneezes, we all will get sick quite quickly.

See Chinese Authorities Buck the Market to Save the Yuan – But for How Long?

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