The exponential growth of foreign assets makes me wonder how China has been able to pay for all of this. Relative to the size of China’s trade surplus the growth in foreign assets is so enormous it boggles my mind how all this foreign asset growth has been, and will be financed. A trillion would be four times their 2007 trade surplus, wouldn’t it?

It’s something that has been talked about, but there is an interesting dynamic in that because Chinese banks don’t have the risk control and management systems Western banks do, they are required to take fewer risks.

One thing that has to be looked at is whether the risk and credit management systems that Western banks used actually reduced risk, or whether they led to a false sense of security and led Western banks to take risks that they should not have.

One clear example of this is mortgage securitization where having a computer model telling you that everything is all right might prevent you from going out to talk to homeowners, look at all of the house flipping, and realize that everything isn’t all right and the computer models are giving bogus answers.

Money changers exist and they are tied to commercial banks (they must be). And commercial bank reporting of FX to SAFE is extremely well administered.

RH: “The obvious policy response could of course be that all fwd business would require 100% cash collateral in CNY”

PBOC doesn’t care how banks hedge FX. Also, for the banks themselves, with regards to FX forwards, they do require order 10% collateral on FX forwards for their tier 2 customers. As you probably know, some customers require no collateral because they have big facilities to draw down on, some of which is apportioned to treasury products.

Most of the major banks are all traded on HK exchanges and are subject to the same reporting requirements that Western banks are. So you should be able to figure something out from the securities filings to HK regulators and other disclosure documents.

You said: “The reason why is that if the Chinese government felt that boosting exports was the best way of stimulating demand, it would write the US a nice big loan for $500 billion which would be used to buy Chinese goods. I really don’t see the US tearing up this check rather than cashing it.“

This has been going on for too long now. The US is credit market is contracting. Overextended institutions need money to cover losses, but they are currently not generating new business. This will hurt the demand side in the US and therefore the supply side in Europe and China.

Has China enough cash to buffer job losses? What is the financial situation of the “new middle class” in the hot spots like Shanghai? Will they “just lose savings” or did they use credit to buy real estate and stocks as well? We hear reports of Chinese companies struggling for money. It is hard to imagine that this will not affect their works, who are customers of retailers.

I worry that China is trying to “grow out of the problem”, because this strategy has worked pretty well. The landscape in its main markets has change. And I fear that this will stall internal demand.

Although the whole system is quite controlled, it is not possible in a vast country like China and commercial banking something that has only been around for a decade at best (remember that in a centrally planned economy banking is a mere bookkeeping and cash dsipensing function) to effectively control (a) a commercial exchange licence system (the banks would have to police that) and (b) enforce the policy governing application approval throughout the country. In addition, the major banks are still completing their first generation back office systems and given the fact that only 4 years ago FX risk was very unusual given the peg, most probably the banks have very little infrastructure, not only to process large numbers of FX transactions, but also to manage the associated credit risks (typically a firm wishing to sell future USD receipts forward would need a credit facility of some kind. I would not expect that the commercil SOE banks would have a good credit mangement system for FX forwards. Posibly during the past year, more and more bright sparks found ways to “hedge” and perhaps, during the past 3-4 months, a lot of that may have matured. If the dministrative situation in the banking system is as I suspect, that might actully not be easy to track centrally and could easily lead to pretty big surprises. The obvious policy response could of course be that all fwd business would require 100% cash collateral in CNY. I wonder if any of these aspects (1) deficient administration especially for credit risk management (2)weaknsses in design, enforcement and approval policy of FX control, have had attention in the Chinese language literature recently.

One way to make that type of business more selective (shaking out speculation) is to require a high cash deposit
(a bit similr to a margin on an exchange traded product).
I wonder if there is something of that kind

thanks, not only the FX positions of Chinese state banks re secret!
The way I understand it then is that the banks have three sources of USD-related liabilities:

(1) deposits from customers who have permission to hold FX deposits onshore

(2) deposits received as part of the recapitaliation (I would assume that these deposits have legal aspect (subordination, posibly convertbility) that allow POBC to treat these deposits as Tier 1 or Tier 2 instruments under the Basle accord

(3) “deposits” resulting from FX swaps with SAFE or POBC

All of these could be hedged, either by entering in spot/forward swaps or by using natural hedges, like USD loans to onshore customers, or by placing FX deposits with offshore affiliates, or with POBC.

Re (1) then, that would look like the most likely source for funding onshore commercial assets (onshore loans, export bills etc). I would guess that the surplus, if any could first be used for placement with own offshore affiliates (who my be subject to stricter arbitrage controls than ordinary western banks) . The remainder would probably go to SAFE. If that is the case it would be logical if the deposits with SAFE would offer the lowest profitmargin (yield-/- cost of funds)

Re (2) These deposits may carry a different rate(payable) (in FX ) than that paid by POBC/SAFE to the same banks on their surplus FX cash, because they are more risky (assuming again that they have low seniority in order to count as capital) Also, in order to hedge them (otherwise gigantic FX exposure would exist), they probably swap thes depositis with POBC/SAFE by selling he FX spot and buying it forward. That would convert the FX into CNY. In oder to price the forward one needs an interest differential. The question then would be would (from the commercial bank’s perspective) the implied USD rate receivedbe the same as paid on th recap deposit or a different one. Also, would the RMB rate paid be he same als, for instance received on CNY reserve requirements, etc

Re (3) similar questions as with (2) I am not familiar with the balance sheet structure in FX (doubt anyone is) but if e go back to (1) swaps could of course be used for both investing surplus FX (instead op depositing and hedging into RMB separately, or to fund deficits in the commercial business.

The point of this is that all these transaction types use interest rates, and that these interest rates may differ from rates used in customer business, and certainly from international (LIBOR) based rates. Hence it is posible that the state subsidizes the banks or vic versa. I would expect that it is the latter and that would make this detailed (apologies) quesion a very legitimate one for equity analysts

Sum it all up and I cannot answer Rien’s question with confidence. These tho are the kinds of questions bank analysts in China should be asking.

finally, 2fish, bad investment is often correlated with high levels of investment. and i suspect the evidence suggests that even poor countries can get a bit drunk and invest a bit more than makes sense.

My understanding is that much of the US dollars held by the banks are matched against US deposits held by the banks so a change in the value of the dollars is matched with the change in bank liabilities. To the extent that this isn’t the case. the PBC has been known to sell banks currency options which means that the currency risk is in the hands of the PBC rather than the banks.

One other point….

bsetser: moreover, if china tried to export its way out, i suspect the international economic system would turn against china

I don’t see the global economic system breaking in this particular way. The reason why is that if the Chinese government felt that boosting exports was the best way of stimulating demand, it would write the US a nice big loan for $500 billion which would be used to buy Chinese goods. I really don’t see the US tearing up this check rather than cashing it.

Long before the US starts going protectionist, someone in Beijing is going to wonder if it really in China’s interest to keep loaning the US so much money, and that is the limit in the current situation.

This is also why I think there are limits to how bad the situation in China can get. Suppose I take $50,000 of my own money and invest it in something like Shanghai stocks and the stock market drops 50%. Whoops. I kick myself, but nothing really bad happens.

Now if I borrow $50,000 and the market drops 5%, I’m really in trouble. If it drops enough then the person that loaned me money could be in trouble. If we are all loaning each other money (i.e. the Japan situation) then we all are in big trouble.

In the case of the Chinese economy, there is this huge pile of cash. So there will be bumps in the Chinese economy, but since China is a net creditor, nothing seriously bad will happen if the value of its assets drop, as long as someone in China has the cash reserves to absorb the loss. This makes it very different from Latin America and other emerging markets.

Getting back to the helicopter analogy. If you have a demand problem, then all you have to do is to fly helicopters and drop money from the skies. So why do nations get into such serious trouble…..

Well, if someone else owns the helicopters……..