Not long ago, it seems that the world was awash in cheap dollars. Many of those cheap dollars could be traced to the generous monetary policies of the Federal Reserve. But many of them also came from the mainland as Chinese recycled their dollar earnings from the sale of exports abroad. Chinese capital flowed into everything from farms in Africa to ports in Sri Lanka and Pakistan, to dairies in New Zealand, energy firms in Canada and Treasuries in the US.
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More recently China started undertaking massive new, and expensive initiatives including the Asian Infrastructure Investment Bank, the New Development Bank, its Silk Route projects and a recapitalisation of the two policy banks that help recycle its reserves.
Suddenly, though, the question has shifted from what China will do with all the capital that flowed in and its arguably excessive reserves to whether it has enough money and adequate reserves at all.
"It is neither the sell-off in Chinese stocks nor weakness in the currency that matters most," notes George Saravelos, a currency strategist in London with Deutsche Bank. "It is what is happening to China's FX reserves and what this means for global liquidity. The People's Bank of China's actions are equivalent to an unwind of QE or, in other words, Quantitative Tightening."
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The question is being asked with some intensity in the wake of the PBoC's decision to move to a more market-determined system to establish the value of the renminbi. The change will make capital controls less rigorous over time and triggered an immediate drop in the value of the currency. Some doomsayers now expect the 3 per cent move down to soon lead to a more dramatic fall as capital outflows pick up and Chinese companies continue to unwind their short-US dollar/long-renminbi carry trades. This would add to pressure on the PBoC to allow the currency to weaken, analysts at research boutique Gavekal say.
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Such concerns are understandable. It is true that Chinese foreign exchange liabilities now amount to some $1 trillion, according to data from the Bank for International Settlements. Allowing for foreign currency borrowed by the subsidiaries of Chinese companies in Hong Kong, the actual amount is higher, as much a total of $1.5 trillion — 15 per cent of China's gross domestic product or 40 per cent of its foreign exchange, Gavekal calculates. Moreover, the combination of a depreciating currency and deepening deflation in the country means the real burden of servicing that debt has become ever more onerous.
By the complicated formulas the IMF has developed, (reflecting a percentage of debt, portfolio flows, exports and money supply) China needs at least $2.6 trillion in foreign exchange reserves, though the calculation assumes no capital controls. Meanwhile, according to Mr Saravelos, China has around $2 trillion of "non-sticky" liabilities including speculative carry trades, debt and equity inflows, deposits by and loans from foreigners that could be a source of outflows.
The combination of future Fed tightening, less money in need of recycling in the hands of oil producers and the uncertain consequences of the swiftly changing circumstances in China is enough to turn most bulls into fearful bears.