Has China lost interest in the euro?
The blogosphere’s eyes and ears in the London foreign exchange market — Macro man — thinks so. China has, he thinks, been a net seller of euros over the past few weeks. That is something of a change. It has been a large net buyer for some time — whether to hit its portfolio targets or in an effort to push the dollar share of its reserves down a bit.
If China’s foreign assets are rising at an annual rate of between $600 billion and $700 billion — as Wang Tao, who just moved to UBS, believes — just maintaining China’s existing portfolio targets might require selling something like $200b of dollars for euros a year. That amounts something like $1 billion of sales a business day, minus whatever euros come directly into the central bank from its intervention in the euro/ renminbi market. My calculations assume the central bank intervenes entirely the dollar/ renminbi market.
I find Macro man’s anecdotal evidence plausible because something clearly changed about a month ago.
Once the RMB reached 7, its appreciation against the dollar stopped cold. Over the last month the RMB dollar looks a lot like a tightly managed peg.
That clearly reflects a policy decision inside China. And it possible that China made a two-fold decision, first to slow (or stop) the appreciation against the dollar and second to do what it could to push the dollar up against the euro. Stopping dollar sales is a rather obvious way to support the dollar if you are a big net seller.
The idea behind such a strategy would to be to get real appreciation through dollar appreciation rather than through renminbi appreciation against the dollar. Or to get Europe off China’s back once China decided to slow its own appreciation against the dollar. Or perhaps just to try to profit from a view that the euro has risen to the point where it is likely to fall.
I of course don’t whether China has actually scaled back its euro purchases. I would be curious what other think. And I certainly don’t know if the decision to scale back euro purchases was tied to the decision to slow the RMB’s appreciation against the dollar — that is pure speculation on my part.
p.s. A fall in Chinese purchases of euros/ rise in Chinese dollar holdings also might help explain the phenomenal recent increase in the Fed’s custodial accounts.
Oh please Brad, even a large central bank like the China PBoC doesn’t have the financial leverage to move the Euro-US Dollar foreign exchange rate with $5 trillion per day traded globally. It would take coordinated Central Bank intervention by the Federal Reserve, Japan Finance Ministry, and ECB to even short-term dent the currency exchange markets, and even then, it might not entirely work as demonstrated by George Soros who broke the the British pound to Euro peg. The China PBoC is attempting to deter short-term US Dollar inflows into the Chinese economy and is having tremendously difficulty at even that small task. With $5 trillion in global currencies traded per day, even the China PBoC is a minnow in the lake. I seriously doubt the China PBoC would be stupid enough to believe that they could influence the US Dollar- Euro currency exchange rates.
Bank of China Raises Fees for Hong Kong Dollar Trades
http://www.bloomberg.com/apps/news?pid=20601089&sid=aL4pFpKudUJM&refer=china
May 7 (Bloomberg) — Bank of China Ltd., the only yuan clearing bank in Hong Kong, said it raised transaction costs for conversions between the city’s currency and the yuan more than sevenfold. “This is clearly a transaction tax on the conversion of Hong Kong dollars into yuan,” said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong. “In concert with the significant slowdown in the pace of yuan appreciation, it reveals a real official concern with hot money inflows and speculative demand for the yuan.” A third of the $80 billion increase in China’s currency reserves in January may have been from Hong Kong.
Yuan Forwards Fall Most Since March as China Controls Gains
http://www.bloomberg.com/apps/news?pid=20601089&refer=china&sid=ajZWz66i_a7g
May 7 (Bloomberg) — Contracts that allow traders to bet on the yuan’s value in 12 months fell the most since March on speculation China is slowing appreciation in the currency to curb investment inflows. Government bonds fell.
China has a lot of products here in Europe so it is certainly not losing interest in the Euro Zone. Wherever you go you find Chinese products ranging from clothing to electronics. I don’t see the Euro doing too badly anyway and I don’t see the significant appreciation of the dollar unless rates rise significantly. But the ECB may lower rates and in turn alter the €.
DC: It would take coordinated Central Bank intervention by the Federal Reserve, Japan Finance Ministry, and ECB to even short-term dent the currency exchange markets
Which isn’t out of the question…..
If you wanted to empty a reservoir, the obvious thing to do would be to open the gates of the dam. The fool thing to do would be to blow up the dam because a flood would ensue downstream.
Economists correctly saw trade barriers as the dam that prevented the world from enjoying the benefits of free trade, and they decided to kind of blow up the dam. The outcome has been a tsunami of products from China and elsewhere flooding richer (for the time being) countries. Every gadget you come up with these days seems to be made in Asia. On the other side, China can’t cope with all the foreign reserves they are earning and face no-win alternatives: keep the peg and loose control of inflation, manage the exchange rates and confront all the speculators, let your currency float freely and risk serious economic dislocations.
When this tide recedes we are going to witness the havoc it has wrought, and it won’t be pretty. Don’t blame the fix exchange rates, though: at this late stage in the game, it may be just as well.
DC. The Fed and perhaps the ECB might agree with you. There draw an analogy between Fed/ ECB sterilized intervention and Chinese sales of dollars for euros, and argue since neither changes the fundamentals, neither should have much impact on price. Fx traders — like Macro man — by contrast tend to think that central bank flow matters. I would note that with Chinese fx reserve growth in the $50-60b a month range, China’s monthly sales of dollars for euros (to hit its portfolio targets) would typically be far larger than the amounts the Fed and ECB would buy/sell in past coordinated interventions.
Perhaps a contributing factor towards the recent rise in the US Dollar versus the Euro is the soaring price of Middle East oil that is only denominated in US Dollars thanks to the US miltary protection racket in the Gulf Arab states. As negotiated in secret agreement by Henry Kissinger with the Saudi Royal family, the crux of US Dollar hegemony is the petrodollar recycling of Gulf Arab state revenue through the Anglo-American banking system. Other than China with excess US Dollar liquidity and significant indigenous energy reserves, other poorer developing states are scrambling to obtain the oil-backed US Dollars for the payment of strategic energy imports. The continued US military occupation of Gulf Arab Oil states perpetuates the financing of US Neo-imperialism.
Off-Topic for Twofish:
Chinese Attack Submarine Strategy Versus US Aircraft Carriers
http://www.upi.com/International_Security/Industry/Analysis/2008/04/28/defense_focus_c21_sub_threat_–_part_2/2692/
The new tactical concept of the Chinese wolf pack that could threaten U.S. aircraft carrier task forces in coming years, however, is very different. Modern diesel-electric submarines can stay underwater for long periods of time and can travel fast in spurts of speed, though they don’t have the endurance of nuclear-powered subs. That speed means they don’t have to surface where they would be easy targets for carrier-launched aircraft. And they don’t have to await for any attack by night either. Attacks by the diesel-electric Kilo or Sung class submarines of the Chinese navy against U.S. carrier battle groups operating in the Central or Western Pacific could occur at any time in the day or night. They would be out to kill 90,000 ton nuclear-powered super-aircraft carriers. China is building large numbers of easily constructed diesel-electric subs in the hope that if a naval war with conventional weapons had to be fought in the Pacific, their subs could overwhelm U.S. anti-submarine warfare defenses by sheer weight of numbers. China’s diesel-electric subs have other advantages going for them besides sheer weight of numbers. As National Defense warned in its cover story this month, "Quiet diesel attack submarines are emerging as the ultimate stealth weapon." These subs can be much smaller than big American or Russian nuclear subs. So they are consequently much harder to detect. The latest diesel-electric drives also are very quiet, and muffling sound is the key stealth weapon in undersea warfare.
Nouriel wrote in one of his latest posts that he thought China would wait for some time to see which one is the bigger threat: inflation, or the slowing of export growth due to the yuan appreciation, rising Chinese wages, shrinking profit margins. I think it is plausible that they want to see the effect of the faster appreciation in the first few months. Roubini thinks, by the way, that no major Chinese financial-economic changes should be expected before the olympic games.
Brad -
As I’m sure you are aware, the daily volume of FX trading is a red herring - it is the net purchases or sales that matter and China’s purchases are large relative to the global net purchases.
As another blogger commented, labor can’t be stored. That is why in a Keynesian framework where output is constrained by demand, it can pay to produce goods to be dumped into the ocean, or to be sold for worthless paper. I think that is the dominant reason for Asian central bank reserve accumulations and that the value of the reserves is a distant second consideration. So, I think these central banks worry more about responses that would force them to cease their current policy than they do about optimizing the value of their reserves. For example, if China is selling euros for dollars (or amassing euros at a slower rate compared to dollars), my guess is that these actions are based on calculations on the relative likelihood of European vs. U.S. retaliation against their currency strategy. Of course, as I’ve said before, the euro is very high now, so anyone buying it is paying a big premium, even after accounting for current differences in the real rates of return on euro and dollar denominated assets. Balanced against the premium for the euro is the worry that dollar debts will become so large that the U.S. will renege on its debts by inflating.
For OPEC countries, I think the value of reserves would be the dominant concern. Maybe they believe (as I do) that the current premium for the euro is overdone. If I were them, I’d buy more yen. The real rate of return on yen denominated assets is not so low compared to other currencies, the yen is substantially undervalued at current rates, and I don’t think OPEC countries would need to worry about negative reactions from Japan (though other Asian central banks might).
It is a crock of BS that China PBoC currency purchases in the $5 trillion per day foreign exchange markets amount to anything especially for the Euro-US Dollar trade. Despite an official closed capital account for the yuan, the Chinese PBoC cannot even contain hot-money inflows into its own sovereign issued currency. Allegations that the China PBoC is engaged in manipulation of the Euro/US Dollar currency rate and derivatives markets are absolute hogwash when a cartel of 10 Wall Street investment banks accounts for $3 trillion daily trading volume. Nowadays, the Chinese can be blamed for anything that is politically correct from global currency manipulation to destroying the environment by emitting too much CO2 gas according to Western pundits.
It seems to me that the OPEC countries have so much real value under the ground that they can be more or less indifferent to currency movements and also inflation. When oil hits $200 or $300 then they will be swimming in cash. China on the other hand has no natural wealth nor does Japan.China though has lots of cheap labour whereas Japan has very little. I do not see that the Yen will be a good bet over the medium to long term, in fact given the demographics, energy prices, food prices and natural resource problems, it seems to me that Japan is in deep doggy-doo and will be livingoff its savings.
PS DC -as pointed out earlier, the $5Tnumber is a red herring as it is the (net) buying at the margin that sets the price not the gross flows.
So now its China PBoC (net) buying at the margin that determines the Euro/US Dollar exchange rate? Assuming that the China PBoC were to reallocate $50 billion USD to Euros during the month of March 2008 on the foreign exchange spot market, it would represent 0.000005% of global currency transactions for that month. The equilvalent transaction would be placing a buy/sell order for 100 shares of IBM stock in order to somehow manipulate the price. The China PBoC will reallocate reserves from USD to Euros to take advantage of market trends; not the other way around. Central Banks are increasingly only a small participant in the global currency exchange markets. And the US Treasury balance sheet of foreign reserves is even smaller than some leveraged Wall Street Hedge funds.
DC: Assuming that the China PBoC were to reallocate $50 billion USD to Euros during the month of March 2008 on the foreign exchange spot market, it would represent 0.000005% of global currency transactions for that month.
But most of those transactions are not directional. I buy $1 billion from you, you buy $1 billion from me, and the price stays constant. If I want to sell $50 billion and I’m not interested in buying, the markets will move.
The other reason that central banks have far more impact on currency prices than the raw numbers suggest is that they affect the market psychology. If the market thinks that the PBC is dumping dollars and buying euros then everyone is going to also start dumping dollars and buying euros to take advantage of the price shift.
Also investment banks can’t afford a $50 billion open position. Investment banks do a lot of volume, but then have to close their positions quickly. If you buy $10 million in US dollars then you have to sell $10 million very quickly, which means that except in very rare cases they don’t have the capital to move markets like central banks can.
I think it’s not so much the level of the currency as the amount of intervention that should be the focus. It would take a growing amount of intervention to keep a currency a certain distance from its natural equilibrium, even absent any response in other capital flows, owing to the greater elasticity of longer-term supply and demand curves for exports and imports. Absent a response from other capital flows, however, the same amount of intervention will result in the same amount of current account surplus. For example, over time a smaller yuan undervaluation would be needed to keep the same surplus in China’s current account, but the amount of intervention needed to keep this surplus would remain the same. Thus, a growing surplus and growing intervention might be consistent with a stable or even appreciating yuan.
DC might be right. Maybe markets are simply to blame for the euro’s movements. I recall not too long ago the euro was at $0.82. Maybe markets are just searching for the head and feet of this new creature.
Twofish,
Even if the China PBoC were to reallocate $50 billion USD into Euros, it wouldn’t be in a single transaction, but spread out over at least a couple weeks. Throwing a mere $50 billion at such a huge market is the equilvalent to spitting into the ocean and expecting a tidal wave. It is noise in this vast market. For example, South Korea’s average daily interbank Korean Won/US Dollar currency volume exceeds $27 billion USD. That is just one country for one day. Global forex average daily trade volume is around $5 trillion.
It looks to me as if the Ukraine is very much a harbinger of things to come in China. "By March (inflation) reached 26% per year. . ." (Anders Aslund in Project Syndicate)caused by a pegged hryvnia.
You are confusing speed with capacity.
I can get a trillion dollars/day in trading volume by taking a million dollars and trading it back and forth a million times per day which is basically what happens.
If you want to see what $50 billion can do, you need to look at the amount of capital that gets traded, and a typical bank only has capital in the hundred million range. Currency is a fast market, but it’s not a particularly huge one since you have relatively small amounts of capital that are being traded very, very rapidly. This means that a $50 billion currency intervention is a relatively large one,
I side with 2fish, don and norman’s dog in this debate — volumes are a product of tons of money moving around quickly b/c a lot of big players don’t want big open positions. China’s impact comes from the fact that it is holdings euros and dollars unhedged and thus is a big net buyer of both. it just happens to buy $ by intervening in the RMB/ $ and to buy euros by selling $ for euros b/c liquidity in the rmb market is still in the dollar market (from what i have been told).
Qingdao — Ukraine also ended up revaluing, something a host of other countries that link their currencies to the dollar and currently face strong inflationary pressures have been quite reluctant to do. But it is a most interesting case.
..and right on cue, China comes back and starts buying euros today…and it’s higher. I guess DC had a word with his guv’nor that it’s time to start buying again…
volumes are a product of tons of money moving around quickly b/c a lot of big players don’t want big open positions. China’s impact comes from the fact that it is holdings euros and dollars unhedged and thus is a big net buyer of both.
Brad
Agree with 2 fish , the problem is ‘cos the trade takes place at such speed (partly ‘cos the margins are razor-thin) the real impact of trades may not appear till some time later- though the SG case was in index futures, the back office ops are pretty much standard. A trader who doesn’t take a holiday is probably the only employee who’s not seen as a better worker - after all, one who covers his tracks/trades can’t do that out of office or so it’s alleged.
If China is an unhedged buyer of both, could it then be assumed that any downward trajectory will be a smooth and steady one?
macroman — thanks for the tidbit. no doubt DC gave them a call indicating that they could no buy w/o moving the market. note the BoR reserves data as well — up over $25b in April. that is a lot of $ that would need to be sold for euros to hit russia’s portfolio target.
judy — no guarantees. china isn’t a forced seller b/c of leverage(so long as its reserves are constant). but if it moved big sums around quickly it could cause a bit of disruption. and well china’s continuous appreciation v the $ was smooth but it also caused china some problems, so it seems to be reconsidering …
china’s impact may come from choosing their moment - plus the psychological effect of a general belief that chinese policies have changed.
how much money did saddam hussein shift when he switched from the dollar to the euro ? hard to beat his move for timing plus impact.
- and 100 dollars invested in i b m stock can shift the markets under certain conditions.
- so can plunge protection teams.
and china’s move to sell the euro, and support their own currency by buying the dollar - if it turns out to be the case - was predicted on this site. so argue all you want, but don’t stop reading it . . .
Having discussed Macroman’s idea of what drives eurodollar on his blog, I understand his argument, but I am still not entirely convinced. His mechanism depends on China being forced to intervene against sales of borrowed dollars, which I guess is most relevant when there is speculation of an imminent revaluation of the renminbi. Personally, I think that the news matters; given the day’s news, I reckon I could tell you at least the direction of eurodollar that day. For example, hints that the Fed is done easing = dollar strengthening; hawkish talk from Trichet = dollar weakening.
By the way, I presume DC’s figures about the insignificance of potential Chinese currency reallocation are rhetorical - do the math!
The trade figures today indicated that China’s trade balance with the United States is shrinking fast. In March, it came to $16.1 billion, the lowest figure for any month in two years and nearly $10 billion below the peak monthly figure of $25.9 billion, reached in October (http://norris.blogs.nytimes.com/2008/05/09/chinese-reversal/). If China’s trade balance with Europe remained stable, would not China have to sell Euro’s to maintain a fixed US dollar to euro reserve ratio?
Macro Man in his blog today, makes a similar argument, that the BRIC central banks now need to purchase fewer Euros to maintain portfolio benchmarks (http://macro-man.blogspot.com/2008/05/has-voldemort-fallen-out-of-love-with.html).
i don’t doubt that China’s surplus with the US is falling, but there is a lot of seasonality in the data. US imports from China always peak in Oct/ Nov before falling off in q1. The US holidays = more demand for Chinese goods in q4; the chinese holidays in q1 = less production.
there is no necessary connection though between china’s trade with europe and its euro/ dollar sales. so long as European importers are paying Chinese producers in dollars - and the Chinese producers are selling dollars to the central bank — the central bank is still accumulating dollars.
the number of dollars it subsequently needs to sell to meet its portfolio target will then be a function of:
a) the number of dollars it is buying (more it buys, the more it needs to sell)
b) the existing composition of China’s portfolio
c) moves in the euro dollar — if the euro’s value rises, china needs to buy fewer euros to hit its portfolio target.
c) the desired composition of China’s portfolio. if China wants to lower the $ share of its portfolio, it has to sell more $.
At least that is how i see it.
But how did the European importers obtain the dollars to pay the Chinese, Brad? By buying them in the market, so Chinese selling of dollars vs euros is conditional on someone else buying (more) dollars vs euro first. This is the problem I have with Macroman’s thesis.
current currency "paradigm" is that the more rampant inflation in a country is, the more it is expected to appreciate. before bringing the case of Ukraine, you might want to check what is the credit growth doing in that country. inflation in most of these mismanaged countries has got NOTHING to do with the peg & "dollar weakness". same thing in China - loan growth is consistently above nominal GDP, yet nobody figures out PRC is a bigger money printer than US. it will all come back to roost, and eventually hryvnias and yuans of this world will fall against the dollar, not rise.