Monday, April 25, 2011

China To Diversify

All those who were hoping global stock markets would surge tomorrow based on a ridiculous rumor that China would revalue the CNY by 10% will have to wait. Instead, China has decided to serve the world another surprise. Following last week's announcement by PBoC Governor Zhou (Where's Waldo) Xiaochuan that the country's excessive stockpile of USD reserves has to be urgently diversified, today we get a sense of just how big the upcoming Chinese defection from the "buy US debt" Nash equilibrium will be. Not surprisingly, China appears to be getting ready to cut its USD reserves by roughly the amount of dollars that was recently printed by the Fed, or $2 trilion or so. And to think that this comes just as news that the Japanese pension fund will soon be dumping who knows what. So, once again, how about that "end of QE" again?

From Xinhua:

China's foreign exchange reserves increased by 197.4 billion U.S. dollars in the first three months of this year to 3.04 trillion U.S. dollars by the end of March.

Xia Bin, a member of the monetary policy committee of the central bank, said on Tuesday that 1 trillion U.S. dollars would be sufficient. He added that China should invest its foreign exchange reserves more strategically, using them to acquire resources and technology needed for the real economy.

And as if the public sector making it all too clear what is about to happen was not enough, here is the private one as well:

China should reduce its excessive foreign exchange reserves and further diversify its holdings, Tang Shuangning, chairman of China Everbright Group, said on Saturday.

The amount of foreign exchange reserves should be restricted to between 800 billion to 1.3 trillion U.S. dollars, Tang told a forum in Beijing, saying that the current reserve amount is too high.

Tang's remarks echoed the stance of Zhou Xiaochuan, governor of China's central bank, who said on Monday that China's foreign exchange reserves "exceed our reasonable requirement" and that the government should upgrade and diversify its foreign exchange management using the excessive reserves.

Tang also said that China should further diversify its foreign exchange holdings. He suggested five channels for using the reserves, including replenishing state-owned capital in key sectors and enterprises, purchasing strategic resources, expanding overseas investment, issuing foreign bonds and improving national welfare in areas like education and health.

However, these strategies can only treat the symptoms but not the root cause, he said, noting that the key is to reform the mechanism of how the reserves are generated and managed.

The last sentence says it all. While China is certainly tired of recycling US Dollars, it still has no viable alternative, especially as long as its own currency is relegated to the C-grade of not even SDR-backing currencies. But that will all change very soon. Once the push for broad Chinese currency acceptance is in play, the CNY and the USD will be unpegged, promptly followed by China dumping the bulk of its USD exposure, and also sending the world a message that US debt is no longer a viable investment opportunity. In fact, we are confident that the reval is a likely a key preceding step to any strategic decision vis-a-vis US FX exposure (read bond purchasing/selling intentions). As such, all those Americans pushing China to revalue, may want to consider that such an action could well guarantee hyperinflation, once the Fed is stuck as being the only buyer of US debt.

Kurt Brouwer's Fundmastery Blog
April 6, 2011, 2:16 PM ET

Stocks, the Fed & QE ll

If you are wondering why there is lots of anxiety about the stock market right now, read on. Under Chairman Ben Bernanke, the Federal Reserve has popularized a form of economic stimulus known as quantitative easing (QE). The first round of QE expired a while back and now we are in the last phase of QE II. QE II is scheduled to finish up by the end of June.

This report spells out the details [emphasis added]:

Top Fed officials believe the securities purchase program has been effective and has helped improve the economy’s performance in recent months. Some want to see how the economy performs later in the year without it. The recovery, in this view, might be likened to a child riding a bicycle with training wheels. How will it perform when the added support comes off?

What is left unsaid here is that the Fed is deathly afraid of the deleveraging process that is underway in the private sector. Real estate prices are falling. Families and individuals are cutting debt, either by paying it off or going through foreclosure. The only entity actively taking on more debt is the government.

Rebuilding banks on the backs of savers

My belief is that the Federal Reserve is desperately trying to deny reality, which is that many of our largest financial institutions ran themselves into the ground in 2008. So, the Fed wants to keep short-term interest rates low. And, remember that is the rate paid on Americans’ savings accounts, money market funds and Treasury Bills.

The Fed also wants long-term rates to be fairly high. By keeping short-term rates low and longer terms rates high, the Fed helps banks makes lots of money. Thus, they can rebuild their battered and tattered balance sheets. Unfortunately, that means they are rebuilding their balance sheets on the backs of anyone trying to save money. Thanks Ben.

QE & the S&P 500

In addition to helping out the banks, the Fed’s so-called quantitative easing policy has also helped the stock market. However, when the first round of quantitative easing ended, the stock market declined.

So, you can imagine there is some concern about stocks now that the announced end of QE ll is fast approaching. Check out this chart that shows the recent history of the stock market coupled with significant QE events:

Source: Calculated Risk

The blue line shows the ups and downs of the S&P 500 from January 2008 to the present time. The red annotations show the timing of significant QE events (if you want to see a bigger version of the chart, just click on the link above).

The stock market peaked in May of ’08 and headed south. The bottoming process coincided with the initial announcements (November & December 2008) and later expansion of QE l (March 2009). March 2009 was also the bottom for the S&P 500. When QE l ended on March 31, 2010, the stock market continued its rally, but began falling over the summer. Then, in August 2010, Fed Chairman Bernanke made remarks suggesting that another round of QE would be forthcoming. Stocks rallied and continued rallying after QE ll was announced in November.

The end of QE ll?

With QE ll almost certainly ending on June 30th, what’s next for the stock market? Well, I believe it will soften again which will lead to calls for QE lll.

Is there a point at which the Fed pulls back and allows the financial markets to sink or swim? Not likely, at least any time soon.

No comments:

Post a Comment