When $4 trillion is too much and $3 trillion is not enough - BBH


Analysts at Brown Brothers Harriman explained that news that China's reserves approached $3 trillion at the end of the last year has spurred expressions of concern.  

Key Quotes:

"Its reserves have fallen by roughly $1 trillion since peaking mid-2014. The irony that is lost on many investors is two years ago pundits were arguing that China had too many reserves and now some are claiming that their reserves are insufficient.  

Insufficient for what? By most measures, they are more than adequate. The reserves are sufficient to cover imports for 18 months. The reserves are three times more than the short-term foreign debt obligations.  China's reserves are insufficient if the current pace of drawdown continues.  

The value of China's reserves fell by $832 bln in 2015-2016. At the current pace of reserve loss, in three and half years, China will not have any reserves.  Of course, this is not going to happen. The IMF argues China's reserves are "adequate" provide capital controls remain. Those capital controls not only remain, but they have been expanded.    

Some observers argue that the decline in China's reserves is equivalent to the amount of Treasuries it is selling.  

This is simply not true.  

China does appear to be reducing its Treasury holdings, but now where near the scale that has been suggested.    

According to the US Treasury data, China's holdings of US Treasuries peaking in late 2013 near $1.32 trillion.  

As of the end of October, which is the most recent data available, US Treasury estimates China's holdings of US government debt stands at about $1.12 trillion.  

The pace appears to have picked up in recent months.  

Of the roughly $200 bln decline in China's Treasury holdings, $125 bln took place since the end of May 2016.  The change in bond prices probably had a limited impact over this period.  Specifically, in June and July, the US 10-year yield, for example, fell 39 bp, but then rose almost as much in the August through October period.    

Swings in foreign exchange values also impact the dollar value of China's reserves.  

Many observers who discuss the decline in China's reserves tend to imply that it is purely a question of volumes. Yet changing prices cannot be ignored. The precise currency allocation of  China's reserves are not known, but for the sake of this thought experiment, assume that in 2014, 20% of China's reserves were in euros.  500 bln euros.  Since then the euro has declined by more than 20% against the dollar since 2014.

If nothing else changed, the dollar value of China's reserves would have fallen by more than $100 bln.  

For the record, the value of US currency reserves is not even $100 bln.  

The way many, if not most observers talk about the capital leaving China is that it is a form of capital flight.  People are voting with their pocketbooks against the policies of the Chinese government.  While there may be an element of that, we think that the situation is more complicated and less worrisome.    

There are two legitimate outflows which many observers do not even cite, let alone estimate:  paying back foreign currency borrowing and direct investment outflows.  

Many Chinese companies borrowed dollars. The yuan was steadily appreciating. This combined with regulations encouraged those companies to swap from dollars to yuan.  That inflated reserves. Once the yuan is not a one-way appreciation bet, and US interest rates begin rising, pressure builds to repay the debt.  That seemed to account for around 2/3 of the capital outflows in 2015.  

The calculations of 2016 are not complete, but the paying down foreign debt appears continued.  Foreign directed investment outflows were averaging around $100 bln a year.  

And although of a smaller magnitude, note that there are around 330k Chinese students in the United States. Due to various changes, most cannot get student loans.  If each takes the new maximum the equivalent of $50k a year out of China is about $16 bln.  And some students report that families can "borrow" from a neighbor's quota which might not be otherwise used.  

This is not to deny that there are private capital outflows from China.  

But the alarmist talk about the decline in reserves in unnecessary.  

When the yuan was appreciating, and capital was pouring into China, officials made it easier to export savings. Now that it is experiencing capital outflows, it is liberalizing inflows.

Nor is this to deny that Chinese officials are in a tough position. If they step away from the intervention to support the yuan and let it fall, it would likely spur a speculative attack.

This would show up in the offshore yuan (CNH), which may be one of the reasons officials engineered the short squeeze there last week. A sharp decline in the yuan would likely exacerbate the rising trade tensions as it would increase the opportunity for China to export its surplus output. Also, a sharp devaluation would slow China's transition to a consumer-service economy.  

The paying back the dollar loans is not an infinite process, but rather, even if extended, a one-off factor.  Slowing outbound direct investment may be assisted numerous host countries are becoming somewhat less receptive to direct investment from Chinese companies, many of which are at least partly state-owned.  

The situation is serious, but it is hardly an existential crisis for China. China's debt situation seems more pressing. All the capital outflows are not undesirable or unlimited.  Moreover, capital controls can be adjusted. There may be no good options with the yuan.  

Slowing the decline can be costly.  

Allowing the full decline would be disruptive. Fortunately, unlike in the summer of 2015 or early 2016, global investors are not taking their cues from developments in China."

Share: Feed news

Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Open Markets involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of FXStreet nor its advertisers. The author will not be held responsible for information that is found at the end of links posted on this page.

If not otherwise explicitly mentioned in the body of the article, at the time of writing, the author has no position in any stock mentioned in this article and no business relationship with any company mentioned. The author has not received compensation for writing this article, other than from FXStreet.

FXStreet and the author do not provide personalized recommendations. The author makes no representations as to the accuracy, completeness, or suitability of this information. FXStreet and the author will not be liable for any errors, omissions or any losses, injuries or damages arising from this information and its display or use. Errors and omissions excepted.

The author and FXStreet are not registered investment advisors and nothing in this article is intended to be investment advice.

Follow us on Telegram

Stay updated of all the news

Join Telegram

Recommended content

Follow us on Telegram

Stay updated of all the news

Join Telegram

Recommended content

Editors’ Picks

EUR/USD bounces from 1.0800 in the US afternoon

EUR/USD bounces from 1.0800 in the US afternoon

EUR/USD lost its bullish momentum and declined toward 1.0800 in the second half of the day on Thursday. The upbeat Jobless Claims and February PMI data from the US helps the US Dollar find demand and weighs on the pair.


GBP/USD drops below 1.2650 as USD rebounds

GBP/USD drops below 1.2650 as USD rebounds

GBP/USD reversed its direction and declined below 1.2650 after rising above 1.2700 earlier in the day. Renewed US Dollar strength on the back of better-than-forecast Jobless Claims and upbeat PMI data makes it difficult for the pair to keep its footing.


Gold challenging the $2,020 mark

Gold challenging the $2,020 mark

Spot Gold eased from a fresh multi-week high of $2,034.86. The US Dollar edged sharply lower during Asian trading hours and remained on the back foot through most of the European session but turned higher ahead of Wall Street’s opening. 

Gold News

Bitcoin price breakdown possible as European Central Bank says BTC fair value is still zero

Bitcoin price breakdown possible as European Central Bank says BTC fair value is still zero

Bitcoin price’s horizontal consolidation continues to extend, but the support level is wearing thin as the days go by. As the current state of uncertainty continues, it is imperative to remember that markets tend not to wait so long.

Read more

Nvidia drives global markets to records, as European stocks defy German economic gloom

Nvidia drives global markets to records, as European stocks defy German economic gloom

Markets are a sea of green after Nvidia’s earnings report has boosted global risk appetite and stock markets surging. Boost to Nvidia’s share price after another monster earnings report and super forecast has led to a collective relief rally across markets.

Read more