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Is the Federal Reseve about to pull the trigger on China?

Is the Federal Reseve about to pull the trigger on China?

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MildSteel

MildSteel

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It appears that Russia is on the ropes economically speaking. They will likely be there for a while. So from the U.S. perspective, the question becomes what to do about China. China has become quite an economic powerhouse by using its cheap labor to export relatively cheap goods to the U.S. However, in order to keep its best customer alive, China has been forced to by U.S. debt and to keep its own economy from stagnating, engage in massive infrastructure projects. Large investors have been able to leverage low interests rates in the U.S. to invest in China and reap huge profits. However, this has left China exposed. What I think the Federal Reserve is about to do is raise those low interests rates, which will have the effect of making those large investors panic, which will result in capital flight from China. China, like its predecessor Japan will likely go into a recession as a result.

So, in the style of another poster here, WHAT SAY YE? Is the Fed about to pull the trigger on China and raise interest rates?
 
Some background

Global banks issue alerts on China carry trade as Fed tightens and yuan falls
........

Three of the world's largest banks have warned that the flood of "hot money" into China is at risk of sudden reversal as the yuan weakens and the US Federal Reserve brings forward plans to raise interest rates, with major implications for global finance.

A new report by Citigroup told clients to brace for a second phase of the "taper tantrum" that rocked emerging markets last year, but this time with China at the eye of the storm.

“There’s a dangerous scenario in which the combination of rising US short-term rates and a more volatile RMB (yuan) could lead to a rather large capital outflow from China,” said the report, by Guillermo Mondino and David Lubin.

They argue that China's credit boom has become a "function" of external dollar funding, mostly through offshore lending in Hong Kong and Singapore to circumvent internal curbs. It is a powerful side-effect of super-loose policies by the Fed, which the Chinese have been unable to control. If so, this may snap back abruptly as dollar liquidity dries up and fickle money returns to the US.

Bank lending to emerging markets has surged by $1.2 trillion (£720bn) over the last five years to $3.5 trillion. The banks have funded most of these loans from short-term sources, leaving the whole nexus extremely vulnerable as the US prepares to tighten. The Fed caught markets badly off guard earlier this month when it suggested that interest rates would jump from near-zero to 1pc next year and 2.25pc the year after, a much faster pace than expected.

Half of this foreign lending is linked to China, where dollar loans have jumped by $620bn since 2009. Roughly 80pc are at maturities of less than one year. The report warned that higher rates might “erode bank’s willingness to roll over their cross-border loans to borrowers in China”.

Speculators have been borrowing dollars to buy Chinese assets, a flow known as the "carry trade". They often do so with leverage and through convoluted means, some involving use of copper or iron ore as collateral. The bet is that the yuan will strengthen, generating a near certain profit on the exchange rate. This has gone badly wrong as the central bank intervenes to force down the exchange rate, causing the yuan to fall 2.5pc against the dollar since January.

Nomura issued a client note on Friday warning that the carry trade is “reversing gear”, describing a break-down of discipline in which almost everybody in China from investors, to manufacturers, exporters, and commercial banks have been playing the game. Most of the borrowing has been in dollars and yen on the Hong Kong market.

Wendy Liu, Nomura’s China strategist, said investors are putting too much hope in the promise of fresh stimulus and infrastructure spending, ignoring the risks of a weak yuan.

She said devaluation is a double-edged sword. It helps cushion the shock of China’s economic slowdown, boosting “the razor-thin margins” on exporters along the Eastern seaboard. It may also mitigate the “coming wave of credit defaults”. But is also exposes the fragility of the system. A view is gaining credence that the weak yuan is an early warning sign that “China's credit bubble may implode imminently”, she said.

The Bank for International Settlements caught the attention of central banks across the world -- especially the Bank of England -- with a report last October warning that foreign loans to China are now large enough to risk a repeat of the 1998 financial crisis in Asia.

“They have more than tripled in four years, rising from $270bn to a conservatively estimated $880bn in March 2013. Foreign currency credit may give rise to substantial financial stability risks associated with dollar funding,” it said. Analysts say dollar loans -- to firms, not the Chinese state -- have since risen to $1.2 trillion. Almost a quarter come from British-based banks. The BIS said the loan-to-deposit ratio for foreign currencies in China has doubled from 100pc in 2005 to 200pc today. Much of this has been through foreign exchange swaps and forms of credit that are hard to track.
....

Credit Suisse says HSBC is heavily exposed, generating a large chunk of its profits from trades linked to China. The Swiss bank says the speculative part of the carry trade has reached $200bn and entails an intricate web of manoeuvres through Hong Kong. “Various indicators point to stress in the system. The risk of a mis-step is increasing,” it said.
Click to expand...

Global banks issue alerts on China carry trade as Fed tightens and yuan falls - Telegraph
 
MildSteel said:
It appears that Russia is on the ropes economically speaking. They will likely be there for a while. So from the U.S. perspective, the question becomes what to do about China. China has become quite an economic powerhouse by using its cheap labor to export relatively cheap goods to the U.S. However, in order to keep its best customer alive, China has been forced to by U.S. debt and to keep its own economy from stagnating, engage in massive infrastructure projects. Large investors have been able to leverage low interests rates in the U.S. to invest in China and reap huge profits. However, this has left China exposed. What I think the Federal Reserve is about to do is raise those low interests rates, which will have the effect of making those large investors panic, which will result in capital flight from China. China, like its predecessor Japan will likely go into a recession as a result.

So, in the style of another poster here, WHAT SAY YE? Is the Fed about to pull the trigger on China and raise interest rates?
Click to expand...

Many factories have already left China. They are going to places like Vietnam. It is not a problem. China needs to focus more on domestic consumption and domestic development. China can invest in themselves. China is a world in itself and is capable of full autarky if it wanted to do it.

I do not think that raising interest rates will have as much impact on the world economy as America seems to hope.

Anyway, I say do it. I bet China is fine. And then what? Raise your interest rates America. Do it.
 
spangledbanner said:
Many factories have already left China. They are going to places like Vietnam. It is not a problem. China needs to focus more on domestic consumption and domestic development. China can invest in themselves. China is a world in itself and is capable of full autarky if it wanted to do it.

I do not think that raising interest rates will have as much impact on the world economy as America seems to hope.

Anyway, I say do it. I bet China is fine. And then what? Raise your interest rates America. Do it.
Click to expand...

China is already experiencing difficulty. If the investment that is currently there starts to dwindle, the economy will contract. Of course, they have large reserves, but it will cause a recession and will thus put a dent in the Chinese economy.
 
MildSteel said:
It appears that Russia is on the ropes economically speaking. They will likely be there for a while. So from the U.S. perspective, the question becomes what to do about China. China has become quite an economic powerhouse by using its cheap labor to export relatively cheap goods to the U.S. However, in order to keep its best customer alive, China has been forced to by U.S. debt and to keep its own economy from stagnating, engage in massive infrastructure projects. Large investors have been able to leverage low interests rates in the U.S. to invest in China and reap huge profits. However, this has left China exposed. What I think the Federal Reserve is about to do is raise those low interests rates, which will have the effect of making those large investors panic, which will result in capital flight from China. China, like its predecessor Japan will likely go into a recession as a result.

So, in the style of another poster here, WHAT SAY YE? Is the Fed about to pull the trigger on China and raise interest rates?
Click to expand...

The way that this, and the #2 post linked article, is written suggests the Fed is holding all the cards on dealing with China. That is really not the case.

China is still holding some $1.3 to $1.4 Trillion in US debt. And unlike Japan who holds a similar amount of US debt, China is not selling it where Japan sometimes does. There is no doubt that China's production and export market is linked strongly to both the US and EU markets, but the level of carry trading is not really going down near as much at the article suggests. That also includes the competition to get involved in emerging markets. Why? The fundamentals of the relationship between the US and China are still the same. For several real and non-debatable core reasons.

First, China still runs a trade surplus with the US. Even with the slowdown in production of our goods there is still reason for China to hold, and even buy new, US debt. It still means that for the most part US companies buying China imports have to pay for them in Chinese currency, and usually on China's manipulated exchange terms. The flip side is also true when China buys our products. But, even if China continues to see a slowdown in producing the products we buy there is still reason to continue to milk the relationship using US debt so long as they run that trade surplus. China still runs a huge foreign exchange reserve, with almost half of it in the form of US dollars (2nd is Euro, 3rd is a mix of India and Russia last time I checked.) So holding US dollars themselves pays no interest, but holding US Debt does. China takes advantage of both conditions... a trade surplus for the cash in that exchange reserve against the basket of other currency and US debt that does pay interest for their overall fiscal position, get it now? The Fed cannot wish that away with rate changes.

Second, because of the above then you have to accept that so long as China has the US in this trade relation then a significant portion of China's earnings have to stay in the form of dollars off the exchange. Even if the Fed increases rates US debt still looks more stable than our competitors. US debt is still the best looking house in a horrible neighborhood of other nation's debt that has flooded the market since the global financial meltdown. And don't forget, the EU is about to engage in what we just ended... QE. So EU debt is about to get more entertaining in valuation for China because of that similar trade relationship. It makes US debt still a safe bet, and with perhaps an uptick in interest if the Fed increases rates. That would end up being a better addition in held liquid securities held by China's wealth fund.

Third, China knows that even with political gridlock odds are the US will not default.

Lastly, look at the below trend... there is reason for it regardless of Fed intentions later this year which may harm some type of investments flowing through China but will do little to the basics of the economic relationship between the US and China. With China still holding a pretty good hand at the table. Future debt with a higher return may push China into a new round of buying US debt. Because of I am not convinced that the Fed could do enough to cause China's credit bubble to implode, the balance sheet for them is still fairly strong.

China-Treasuries1.jpg
 
MildSteel said:
It appears that Russia is on the ropes economically speaking. They will likely be there for a while. So from the U.S. perspective, the question becomes what to do about China. China has become quite an economic powerhouse by using its cheap labor to export relatively cheap goods to the U.S. However, in order to keep its best customer alive, China has been forced to by U.S. debt and to keep its own economy from stagnating, engage in massive infrastructure projects. Large investors have been able to leverage low interests rates in the U.S. to invest in China and reap huge profits. However, this has left China exposed. What I think the Federal Reserve is about to do is raise those low interests rates, which will have the effect of making those large investors panic, which will result in capital flight from China. China, like its predecessor Japan will likely go into a recession as a result.

So, in the style of another poster here, WHAT SAY YE? Is the Fed about to pull the trigger on China and raise interest rates?
Click to expand...

I have not been focusing on economic aspects of China recently. They had had a sticky spot, but were doing okay in a slower way, last I looked.
One thing about higher rates will be an increase in the Dollar value. That would make China relatively more competitive in foreign markets.
It will cause further substitution of domestically produced trinkets in the US and so a widening trade deficit. China would tend to expand on that reckoning.
So I am not sure.
 
OrphanSlug said:
The way that this, and the #2 post linked article, is written suggests the Fed is holding all the cards on dealing with China. That is really not the case.

China is still holding some $1.3 to $1.4 Trillion in US debt. And unlike Japan who holds a similar amount of US debt, China is not selling it where Japan sometimes does. There is no doubt that China's production and export market is linked strongly to both the US and EU markets, but the level of carry trading is not really going down near as much at the article suggests. That also includes the competition to get involved in emerging markets. Why? The fundamentals of the relationship between the US and China are still the same. For several real and non-debatable core reasons.
Click to expand...

Although your response demonstrates a command of the mechanics of the trade relationship that China has with the U.S. it does not deal with the premise of the assertion that China has been able to sustain its economic growth recently through investment in large infrastructure projects and the rise in value of real estate that has been driven to a large extent by investment using low interest borrowed dollars. When those interest rates rise, the incentive to maintain those investments will evaporate and to avoid losses, large investors will be forced to dump those investments like a hot potato. At that point the Chinese economy will contract, and although the Chinese will be able to keep a collapse from occurring because of their large foreign reserves, there will be a recession nonetheless. Your analysis of the mechanics of the trade relationship that the U.S. has with China does not address this issue, and as such, the premise stands.
 
MildSteel said:
It appears that Russia is on the ropes economically speaking. They will likely be there for a while. So from the U.S. perspective, the question becomes what to do about China. China has become quite an economic powerhouse by using its cheap labor to export relatively cheap goods to the U.S. However, in order to keep its best customer alive, China has been forced to by U.S. debt and to keep its own economy from stagnating, engage in massive infrastructure projects. Large investors have been able to leverage low interests rates in the U.S. to invest in China and reap huge profits. However, this has left China exposed. What I think the Federal Reserve is about to do is raise those low interests rates, which will have the effect of making those large investors panic, which will result in capital flight from China. China, like its predecessor Japan will likely go into a recession as a result.

So, in the style of another poster here, WHAT SAY YE? Is the Fed about to pull the trigger on China and raise interest rates?
Click to expand...


No, the FED will not raise interest rates.

For one, they would immediately take a bath on their massive stock pile of GSE Mortgage backed securities.

Since the FED has no equity they'll be forced to operate at a negative capital position for the foreseeable future.

Their massive pile of Treasuries will continue to put downward pressure on interest rates and the FED is in no hurry to unload them.

Second, China doesn't buy our Securities to prop up our economy, they buy our Securities to devalue their over valued currency which helps to increase their exports.

Im sure they're well aware that Stimulus isn't a effective means of growing the American or any other economy.
 
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