RGE - The latest sign the apocalypse is upon us … CNY funded carry trades
リンク: RGE - The latest sign the apocalypse is upon us … CNY funded carry trades.
Brad Setser | Jan 26, 2007
If what rational world does it make sense for the currency of a high-investment, fast growing, still quite poor country to be the funding currency for a carry trade?
The Japanese yen and Swiss franc as funding currencies I get, even if it is hard to pin down the size of yen-funded carry trades using the balance of payments data. Japan and Switzerland are wealthy slow growing economies with lots more capital than people. China not so much.
Though – picking up on something HK raised in the comments on a previous post, the notion that CNY appreciation would push up the currencies of all of Asia, including Japan, doesn’t necessarily seem to be holding. Most of emerging Asia has been appreciating along with or faster than China. But Japan hasn’t been. And still isn’t. Japan hasn’t been a good proxy – at least in the fx sense – for China. Now the weak yen seems to emerging along side the weak RMB as a constraint on the willingness of a country like Korea to allow further appreciation.
The yuan carry trade is apparently financed with offshore yuan – which are a lot cheaper than onshore yuan. Philip Bowring in the Asian Sentinel:
The latest throw of the dice proffered as an “investment idea” is to take advantage of the low cost of borrowing in yuan in the offshore market. The implied cost of 12-month money is just 0.7 percent, which makes it about as cheap a funding currency as the yen.
But if banks can lend offshore yuan at 0.7%, someone else must be willing to hold yuan denominated accounts that pay even less in the hope of currency appreciation. There are two sides to this trade. And, well, funding a carry trade in the currency of a country facing enormous appreciation pressures is kind of risky. But it is increasingly hard to make a buck. Borrowing short-term in dollars and lending long-term in dollars doesn't cut it any more.
While I am on the topic, the WSJ’s oped on the “People’s Investment Corporatation” wasn’t totally off the wall. Which is a little unusual. But it wasn’t totally unobjectionable either.
Technically, foreign currency reserves are a central bank asset, not a liability (the Journal wrote: “Foreign-exchange reserves are liabilities on a central bank's balance sheet, not found money”). But the broader point the Journal was trying to make is right. The PBoC has issued liabilities (sterilization bills, currency) to finance its growing assets, and it cannot just give away its assets … if someone else wants to manage some of the reserves now managed by the PBoC, it needs to buy the reserves off the PBoC with cash (which would allow the PBoC to reduce its liabilities).
More importantly, the Journal tries to argue that China’s rapid reserve growth requires a lot more capital account liberalization while remaining silent on the bigger issue of whether the RMB needs to appreciate.
That is a mistake. Why? China may still have more controls on outflows than on inflows (though I am not sure about that) but the recent trend has clearly been to loosen outflow controls and tighten inflow controls. And, as the Journal notes, so far lifting controls on capital outflows hasn’t had much effect. Investors aren’t flocking to the qualified to China's “Qualified Domestic Investor Initiative” scheme. Chinese savers prefer to hold appreciating RMB than depreciating dollars. Letting Chinese investors buy US stocks may not change that much either: Chinese stocks recently have been rising far faster than US stocks.
More importantly – as Stephen Jen notes – the undervalued RMB currently makes Chinese assets, not just Chinese goods, incredibly cheap. Jen:
A cheap CNY not only makes Chinese products cheap, but also makes Chinese companies cheap. In a way, Chinese enterprises are being offered to foreigners at discount prices. At the same time, the purchasing power of domestic investors looking to invest overseas is compromised by the cheap currency.
That is why China limits capital inflows. Greenfield FDI is welcome. Foreign purchases of existing Chinese businesses generally are not. Absent those inflow controls, there would be a lot of demand for Chinese assets at current exchange rates.
Liberlizing China’s capital account while holding the exchange rate constant would just generate outflows. It would also permit big inflows.
Comments
I wish I knew the full answer to 1). Obviously capital controls are part of it -- otherwise, no one would keep yuan on deposit offshore for less than the onshore deposit rate, or lend for less than the onshore inter-bank rate. And obviously expectations of yuan appreciation are also part of it. Low yielding yuan deposits can still make sense if you think the yuan will appreciate.
But one the questions that came to my mind while reading bowring (who used to the edit the far east economic review, so presumably he knows what he is talking about) is why is the cost of one year offshore yuan so low .... it was far lower than i expected.
Additional insights from readers would be most appreciated.
But one the questions that came to my mind while reading bowring (who used to the edit the far east economic review, so presumably he knows what he is talking about) is why is the cost of one year offshore yuan so low .... it was far lower than i expected.
Additional insights from readers would be most appreciated.
Written by bsetser on 2007-01-26 14:47:11
Brad,
Excuse me for not quite seeing the connection between offshore Yuan carry trade and mainland China being poor. Offshore yuan, if anything, is just interest free loan to the PBC. I suppose if you happen to hold them in Taiwan or southeast Asia, there is no easy way for you to generate some interest off it, similar to USD held under matresses around the world. No it does not make sense for a poor country to have populace holding USD paper under mattresses as that indeed represent loss of interest and opportunity cost of forgone investment, but as far as China or PBoC is concerned offshore Yuan holdings are free loans and represent investment in the mainland. How investors want to play with that doesn't seem to affect China one way or the other until they come back onshore.
Back to the carry trade, does it really have much effect on the real economies other than lowering interest rates of the higher growth economies?
Excuse me for not quite seeing the connection between offshore Yuan carry trade and mainland China being poor. Offshore yuan, if anything, is just interest free loan to the PBC. I suppose if you happen to hold them in Taiwan or southeast Asia, there is no easy way for you to generate some interest off it, similar to USD held under matresses around the world. No it does not make sense for a poor country to have populace holding USD paper under mattresses as that indeed represent loss of interest and opportunity cost of forgone investment, but as far as China or PBoC is concerned offshore Yuan holdings are free loans and represent investment in the mainland. How investors want to play with that doesn't seem to affect China one way or the other until they come back onshore.
Back to the carry trade, does it really have much effect on the real economies other than lowering interest rates of the higher growth economies?
Written by HZ on 2007-01-26 19:39:22
HZ -- poor countries usually have too little capital relative to their supply of labor (ergo, they are poor) and investment needs in excess of domestic savings, so they offer high interest rates to attract funds from abroad ... at least that was how things used to work. There is an enormous difference between the capital to labor ratio in Japan and Switzerland and China. and while you can argue china is also aging, the effect of aging (i.e. a shrinking labor force) is entirely offset in China's case by rural to urban migration.
Written by bsetser on 2007-01-26 20:55:03
I would like to make 3 points.
1) RMB is not broadly used in trade outside of China or with China. Those offshore RMB deposits most came from 2 sources. First, RMB is accepted to encourage Chinese tourists to spend more money when they are abroad. Second, frequent visitors to China like to keep some RMB cash at hand for convenience and for avoiding exchange cost.
2) Until now, as I understand, there is no formal channel for the offshore RMB to come back to China. You can call this capital control. (This is about to change, there is plan to create a RMB bond market in Hong Kong.) So the offshore RMB is really cash under the mattresses for any financial institute who has accepted the RMB deposit. I guess that the relative high supply of offshore RMB and the relative low demand explains the very low offshore interest rate.
3) As about “poor country”, I agree with HZ, the offshore RMB is interest free liability for PBoC and can only be viewed as benefit. Although China is “high-investment, fast growing”, it is not short of financial capital. The evidence is trillions of RMB deposit in the bank. The top scant resource for China at this point is a healthy and efficient financial system (or more broadly the market system). Even if the offshore RMB carry trade has any harm for China, that amount is so small comparing with the onshore deposit, the effect is negligible.
1) RMB is not broadly used in trade outside of China or with China. Those offshore RMB deposits most came from 2 sources. First, RMB is accepted to encourage Chinese tourists to spend more money when they are abroad. Second, frequent visitors to China like to keep some RMB cash at hand for convenience and for avoiding exchange cost.
2) Until now, as I understand, there is no formal channel for the offshore RMB to come back to China. You can call this capital control. (This is about to change, there is plan to create a RMB bond market in Hong Kong.) So the offshore RMB is really cash under the mattresses for any financial institute who has accepted the RMB deposit. I guess that the relative high supply of offshore RMB and the relative low demand explains the very low offshore interest rate.
3) As about “poor country”, I agree with HZ, the offshore RMB is interest free liability for PBoC and can only be viewed as benefit. Although China is “high-investment, fast growing”, it is not short of financial capital. The evidence is trillions of RMB deposit in the bank. The top scant resource for China at this point is a healthy and efficient financial system (or more broadly the market system). Even if the offshore RMB carry trade has any harm for China, that amount is so small comparing with the onshore deposit, the effect is negligible.
Written by jye on 2007-01-27 00:35:47
"..."The yearly rate of growth of the central bank balance sheet (monetary pumping) relative to real economic activity climbed to 28.2% in September 2005. In February this year the yearly rate of growth of the relative pumping stood at 22.1%." Read the above then read it again until it makes sense. China has been pumping like mad, more so than the Fed. With China pumping and Japan's interest rates still hovering near zero, and with the UK's housing bubble at least as big as that in the US, is the US$ poised for the 50% drop that everyone thinks is coming?... Much of the answer to the above depends on interest rates in Japan, Europe, China, and the US, but it is by no means a certainty that the US$ is in any "short term" death spiral..." - '9th Inning Liquidity', 06/01/06 http://globaleconomicanalysis.blogspot.com/2006/06/9th-inning-liquidity.html
"...By directing its demand to dollar-priced commodities China has significantly contributed to their overvaluation versus other goods and services priced in US dollars. (Whilst China cannot print dollars and therefore lift prices of all the goods and services priced in US dollars, it can push prices of some goods relative to other goods)... For the time being, the loose monetary policy of China will continue to provide strong support for commodity prices. It is not possible to tell how long can China continue with its loose policy and rigid exchange rate..." http://www.mises.org/story/2134
"...The sustained economic boom has left the central government relatively awash in tax revenues but still unable or unwilling to spend the money on a host of problems that Beijing itself has identified as in urgent need of funding..." http://www.ft.com/cms/s/16fe2e00-ace2-11db-9318-0000779e2340.html
"...Every $1 of China's overseas sales requires four times the energy used by the U.S, seven times that of Germany and ten times that of Japan, Vice Commerce Minister Gao Hucheng said last week, citing Chinese research..." http://www.bloomberg.com/apps/news?pid=20601087&sid=ap6lknQHqw8M&refer=home
"BMO Financial Group has been ranked the number one bank in the new Foreign Exchange currency pairs trading system in China. BMO leads the list of ten notable international competitors among approved market makers. No other North American institution ranks in the top 10..." http://www2.bmo.com/bmo/files/news%20release/4/1/bmo_yuan_trading_jan2306_en.htm
Bank of Montreal gets yuan license - http://www1.cei.gov.cn/ce/doc/cen2/200507062295.htm
"...Banks hope the visit by Canada's second-highest-ranking cabinet minister will help smooth over a recent quarrel between the Harper government and Beijing over human rights... "The Chinese will know Flaherty is a key minister in Harper's inner circle and they will see his arrival in China as a signal that Canada is prepared to move forward..." Bank of Nova Scotia spokesman Frank Switzer, who said Scotiabank is the only Canadian bank to have a branch in Shanghai, believes Flaherty's name will help. "In the game of global competitiveness, it's great to have support from government officials, particularly the Finance Minister,"..." http://chineseinvancouver.blogspot.com/2007/01/emerson-flaherty-to-meet-with-chinese.html
"..."Scotiabank will become the foreign strategic partner of Dalian Bank, while IFC will be a financial investor," said a banking source, who declined to be identified... Scotiabank spokesman Frank Switzer declined to comment... IFC and Dalian Bank declined to comment..." http://chineseinvancouver.blogspot.com/2007/01/scotiabank-ifc-eyeing-stake-in-chinas.html
"...By directing its demand to dollar-priced commodities China has significantly contributed to their overvaluation versus other goods and services priced in US dollars. (Whilst China cannot print dollars and therefore lift prices of all the goods and services priced in US dollars, it can push prices of some goods relative to other goods)... For the time being, the loose monetary policy of China will continue to provide strong support for commodity prices. It is not possible to tell how long can China continue with its loose policy and rigid exchange rate..." http://www.mises.org/story/2134
"...The sustained economic boom has left the central government relatively awash in tax revenues but still unable or unwilling to spend the money on a host of problems that Beijing itself has identified as in urgent need of funding..." http://www.ft.com/cms/s/16fe2e00-ace2-11db-9318-0000779e2340.html
"...Every $1 of China's overseas sales requires four times the energy used by the U.S, seven times that of Germany and ten times that of Japan, Vice Commerce Minister Gao Hucheng said last week, citing Chinese research..." http://www.bloomberg.com/apps/news?pid=20601087&sid=ap6lknQHqw8M&refer=home
"BMO Financial Group has been ranked the number one bank in the new Foreign Exchange currency pairs trading system in China. BMO leads the list of ten notable international competitors among approved market makers. No other North American institution ranks in the top 10..." http://www2.bmo.com/bmo/files/news%20release/4/1/bmo_yuan_trading_jan2306_en.htm
Bank of Montreal gets yuan license - http://www1.cei.gov.cn/ce/doc/cen2/200507062295.htm
"...Banks hope the visit by Canada's second-highest-ranking cabinet minister will help smooth over a recent quarrel between the Harper government and Beijing over human rights... "The Chinese will know Flaherty is a key minister in Harper's inner circle and they will see his arrival in China as a signal that Canada is prepared to move forward..." Bank of Nova Scotia spokesman Frank Switzer, who said Scotiabank is the only Canadian bank to have a branch in Shanghai, believes Flaherty's name will help. "In the game of global competitiveness, it's great to have support from government officials, particularly the Finance Minister,"..." http://chineseinvancouver.blogspot.com/2007/01/emerson-flaherty-to-meet-with-chinese.html
"..."Scotiabank will become the foreign strategic partner of Dalian Bank, while IFC will be a financial investor," said a banking source, who declined to be identified... Scotiabank spokesman Frank Switzer declined to comment... IFC and Dalian Bank declined to comment..." http://chineseinvancouver.blogspot.com/2007/01/scotiabank-ifc-eyeing-stake-in-chinas.html
Written by Guest on 2007-01-27 07:30:15
Global Economic Imbalances not China's fault
http://www.asianewsnet.net/columnist.php?aid=7534
"China is in fact not the real source of the global trade imbalance", argue Chinese Economists. It also reflects the high savings rate and comparatively low level of consumer spending in China compared to the low savings rate and high spending in the United States. "Our trade partners, such as the United States and the European Union, should also shoulder the corresponding responsibilities," said Mei Xinyu, an expert at the Chinese Academy of International Trade and Economic Cooperation, the research institute under the commerce ministry. An increase in technology imports from the US is also dependent on whether the US government removes or eases its export control policies toward end-users.
Written by Dave Chiang on 2007-01-27 15:40:04
because there are very real concerns, although perhaps not enough, about how the technology is being used and abused:
"Censorship of Chinese web sites set to intensify as ruling party looks to clamp down on free speech and anti-communist propaganda... The vast majority of those users have no access to overseas Chinese web sites offering uncensored opinion and news critical of the ruling party. But even in heavily monitored China, news of official misdeeds and dissident opinion has been able to travel through online bulletin boards and blogs. Hu told officials to intensify control even as they seek to release the internet's economic potential. "Ensure that one hand grasps development while one hand grasps administration," he said...." http://www.itpro.co.uk/internet/news/102956/chinese-communist-leader-wants-to-purify-internet.html
but that's not the topic of this post.
"Censorship of Chinese web sites set to intensify as ruling party looks to clamp down on free speech and anti-communist propaganda... The vast majority of those users have no access to overseas Chinese web sites offering uncensored opinion and news critical of the ruling party. But even in heavily monitored China, news of official misdeeds and dissident opinion has been able to travel through online bulletin boards and blogs. Hu told officials to intensify control even as they seek to release the internet's economic potential. "Ensure that one hand grasps development while one hand grasps administration," he said...." http://www.itpro.co.uk/internet/news/102956/chinese-communist-leader-wants-to-purify-internet.html
but that's not the topic of this post.
Written by Guest on 2007-01-28 07:25:42
Sorry DC, China is, in fact, a key (tho not the only) source of the global trade imbalance. Tis hard to argue away what is likely to be a $300b plus/ greater than 10% of GDP current account surplus. That surplus is global -- Chinese exports to Europe, Africa and the Middle east are all growing very quickly, and those are places that do save. Chinese financing increasingl makes it possible for the US not to save. And with tax revneues growing faster than gov. spending (See above) and business investment self financed freeing up money for the banks to lend to the PBoC, it also isn't hard to see how Chinese policies have contributed to china's high savings rates. Export controls are a very small factor.
I don't think US policy is blameless, but it is hard for me to argue that chinese policy hasn't contributed in a big way to current imbalances. RMB depreciation (a policy choice) in the face of strong productivity growth (a good thing) combined with a rising fiscal surplus (a policy choice) and bank lending curbs to avoid inflation ( a policy choice) = massive increase in China's current account surplus.
I don't think US policy is blameless, but it is hard for me to argue that chinese policy hasn't contributed in a big way to current imbalances. RMB depreciation (a policy choice) in the face of strong productivity growth (a good thing) combined with a rising fiscal surplus (a policy choice) and bank lending curbs to avoid inflation ( a policy choice) = massive increase in China's current account surplus.
Written by bsetser on 2007-01-28 07:56:10
Proposal to explain the offshore yuan situation:
1) Since the yuan overtook the HK dollar, the average Chinese seem to collectively have switched from doing business in HK$ into yuan:
http://www.chinadaily.com.cn/bizchina/2007-01/19/content_787505.htm
2) According to the same source, merchants in the Pearl River delta seemed to have made the switch even earlier, in October 2006.
3) Now suppose the Chinese rich, equally collectively, would switch their offshore dollars into offshore yuan (or start buying offshore yuan instead of dollar with new money).
4) This would mean a flood of offshore yuan, and a decrease in purchases of US treasury bills; BVI is one of the largest FDI sources for China, and every self-respecting Hong Kong company seems to have a BVI parent, so watching the British Virgin Islands might be a good indicator of what is going on offshore
5) As no economists or central banks are involved in this process, any of those moves might not necessarily have to make sense according to standard thinking. The rationale may be a combination of parking money somewhere safe and opportunistic gambling/speculation.
For this to have an impact, the numbers would have to be significant. But why not? What if 5%, 10% or 20% of the yuan that is supposed to sit in Chinese bank accounts has made its way elsewhere?
1) Since the yuan overtook the HK dollar, the average Chinese seem to collectively have switched from doing business in HK$ into yuan:
http://www.chinadaily.com.cn/bizchina/2007-01/19/content_787505.htm
2) According to the same source, merchants in the Pearl River delta seemed to have made the switch even earlier, in October 2006.
3) Now suppose the Chinese rich, equally collectively, would switch their offshore dollars into offshore yuan (or start buying offshore yuan instead of dollar with new money).
4) This would mean a flood of offshore yuan, and a decrease in purchases of US treasury bills; BVI is one of the largest FDI sources for China, and every self-respecting Hong Kong company seems to have a BVI parent, so watching the British Virgin Islands might be a good indicator of what is going on offshore
5) As no economists or central banks are involved in this process, any of those moves might not necessarily have to make sense according to standard thinking. The rationale may be a combination of parking money somewhere safe and opportunistic gambling/speculation.
For this to have an impact, the numbers would have to be significant. But why not? What if 5%, 10% or 20% of the yuan that is supposed to sit in Chinese bank accounts has made its way elsewhere?
Written by Indonesia on 2007-01-29 01:01:07
Dr. S!
Is the pileup of rmb liquidity offshore the counterpart of double invoicing? Once upon a time, such balances were held in dollars, but with the rmb on the rise versus the buck, it makes sense to keep the rmb offshore. Why do this? Rainy-day money. Or, accumulation of cash to be used for foreign investment. Or, as one of your contributors suggests, these could be balances owned by nonresidents.
Is the pileup of rmb liquidity offshore the counterpart of double invoicing? Once upon a time, such balances were held in dollars, but with the rmb on the rise versus the buck, it makes sense to keep the rmb offshore. Why do this? Rainy-day money. Or, accumulation of cash to be used for foreign investment. Or, as one of your contributors suggests, these could be balances owned by nonresidents.
Written by A. P. Simkin on 2007-01-29 05:00:58
Dr S!
Have you looked at the Balance of Offshore Accounts on the MOF website? Specifically, the yen call loans to nonresidents [top line]. Evidently, this does not include yen call loans to residents. For that, you can look at the BOJ balance sheet data on the banks. There is a specific item on yen call loans. Of course, this assumes that the carry trade is funded by call loans and that they are all done domestically.
Have you looked at the Balance of Offshore Accounts on the MOF website? Specifically, the yen call loans to nonresidents [top line]. Evidently, this does not include yen call loans to residents. For that, you can look at the BOJ balance sheet data on the banks. There is a specific item on yen call loans. Of course, this assumes that the carry trade is funded by call loans and that they are all done domestically.
Written by A. P. Simkin on 2007-01-29 05:06:47
Indo- thx. interesting.
AP Simkin -- I really need to learn more about the Japanese BoP data. It isn't something that I regularly use, but now that the yen is looking a wee bit misaligned, well, I really need to find the time to look at it more closely.
AP Simkin -- I really need to learn more about the Japanese BoP data. It isn't something that I regularly use, but now that the yen is looking a wee bit misaligned, well, I really need to find the time to look at it more closely.
Written by bsetser on 2007-01-29 11:11:07
You might also want to have a look at this:
http://www.chinadaily.com.cn/english/doc/2004-06/30/content_344072.htm
http://www.chinadaily.com.cn/en/doc/2003-08/12/content_254169.htm
I don't think the flow of assets in Asia makes sense from a "normal" viewpoint.
Capital flight is not an insignificant issue. Daewoo one day found that 80 billion US$ were missing from their balance sheet. Some of that sum probably never existed to begin with, but some of it probably still today provides some nice real estate, golf club memberships, luxury cars and gambling funds for the "survivors" somewhere in a nice sunny place.
If a single company in a tiny country with 50 million people and relatively insignificant foreign inflows can misplace 80 billion US$, what might happen in China? Embezzling half a billion dollars from the Bank of China certainly does not seem to pose to big of a problem, despite all the foreign shareholders and auditors...
http://www.chinadaily.com.cn/english/doc/2006-02/08/content_518248.htm
http://www.chinadaily.com.cn/english/doc/2004-06/30/content_344072.htm
http://www.chinadaily.com.cn/en/doc/2003-08/12/content_254169.htm
I don't think the flow of assets in Asia makes sense from a "normal" viewpoint.
Capital flight is not an insignificant issue. Daewoo one day found that 80 billion US$ were missing from their balance sheet. Some of that sum probably never existed to begin with, but some of it probably still today provides some nice real estate, golf club memberships, luxury cars and gambling funds for the "survivors" somewhere in a nice sunny place.
If a single company in a tiny country with 50 million people and relatively insignificant foreign inflows can misplace 80 billion US$, what might happen in China? Embezzling half a billion dollars from the Bank of China certainly does not seem to pose to big of a problem, despite all the foreign shareholders and auditors...
http://www.chinadaily.com.cn/english/doc/2006-02/08/content_518248.htm
Written by Indonesia on 2007-01-29 21:24:37
(2) If novelty in the funding currency for carry trades is the game, I humbly suggest the Czech Koruna (CZK), currently yielding 2.50%. I make no guarantees on the profitability of this trade, but your banker friends should be suitably impressed.
(3) WSJ: Foreign-exchange reserves are liabilities on a central bank's balance sheet, not found money.
This statement is inexcusable. Any reasonably competent economics undergraduate will tell you it's factually incorrect. It's what they call an elementary howler.
WSJ reporting is nearly as good as it gets when it comes to financial journalism. WSJ op-eds are, well, e-mailed from another dimension.