Make no mistake. China’s economy is slowing.
After pumping a massive amount of central bank stimulus into the economy last year that caused local property markets to soar, the People’s Bank of China is pumping the brakes. For the full year 2016, the PBoC pumped a net 1.727 trillion Chinese yuan into mainland financial markets; that figure was up +5,857% versus the amount of net liquidity it provided in 2015.
Historically, these credit booms result in a painful deleveraging. Investors flee. The country’s currency falls into a tailspin. We think the PBoC will continue to guide the Chinese economy to slower growth and anyone predicting otherwise is missing a key piece of the puzzle. Hedgeye Senior Macro analyst Darius Dale explains why in the video above:
“The issue with expecting that there will be a material currency devaluation of the yuan on the order of -35% is the fact that China has a closed capital account. You just don’t have the same sudden stop risk that you have in other emerging market economies where you have seen material devaluations on this magnitude.”
What a closed capital account essentially boils down to is that companies, banks and individuals can’t move substantial amounts of money in or out of the country without bumping up against the government’s stringent rules and regulations.
This largely explains away the possibility of material currency devaluation in China. Dale compares China to the 25 some-odd other emerging markets we track across a variety of metrics:
- Short-Term External Debt (as a percentage of total foreign direct investment): “This is a proxy for how much money China needs to pay back to foreigners.” It’s only 10% versus about 19% for other emerging markets.
- Inbound Portfolio Investment: “This is the biggest culprit of short term large currency fluctuations.” On that measure, China has a lowly 3% relative to 16% for the average of other Emerging Markets.
- Dollar-Denominated Debt (as a percentage of foreign exchange reserves): It’s only about 35% versus 100% for the average of most other emerging market economies.
Dale concludes:
“I think what people are expecting is some kind of Emerging Market-style currency crash that we’ve seen in historic episodes. But they’re not asking what’s the probability of this happening in China? The math would suggest that it’s unlikely that it’s going to happen, at least certainly not to the same magnitude.”
Click here for more on why Chinese central bankers won’t allow a currency crash.
