On Wall Street, there are several events during the year when the Masters of the Universe get together and share ideas. One of the most important of these is The Grant’s Interest Rate Observer conference, which took place on Wednesday at the Plaza Hotel in New York City.
There, one investor told the entire room of hedge fund managers how long China has before it runs out of foreign exchange reserves.
The country, said Anne Stevenson-Yang co-founder of J Capital Research, has 9 months before its currency “reserves are down to a perilous point.”
She calculated that reserves, this summer around $3.4 trillion, have dwindled down to $2.9 trillion.
“In 12 months there will be a currency crisis of around 15%,” she said. “There will be a banking crisis two years later.”
Go with the flow
China has been experiencing currency outflows of varying (though generally dramatic) degrees since last August when the country devalued its currency, the yuan, by 2%. As its economy slows, more and more people want to trade in their yuan for some other currency.
None of this is good for the government, which needs this cash to pull off the very difficult trick transitioning its economy from one based on investment, to one based on consumer consumption. That means restructuring debt-laden corporations and doing things like supporting millions of people when they’re laid off.
Plus, as Stevenson-Yang pointed out in her presentation, the government needs this cash to keep cash flowing through the economy.
“Without constant injections of cash, the financial system would not be able to transact,” she said. She thinks the system needs something around 70 trillion yuan a year to keep going.
Because of all of this, the government has put on some pretty draconian capital controls to stem outflows, and they have eased. According to government data, only $29 billion left the country in February as opposed to $99 billion in December. In March, the government says reserves rose by $10 billion.
Stevenson-Yang isn’t totally buying that though.
“The PBOC [People’s Bank of China] is using forwards and other techniques to hide outflows. The volume of swaps, forwards, and options not totals $4.4 trillion since October. Deposits against those swaps could be as high as $800 billion. Some of that money may be obscuring the decline in forex reserves,” she wrote in her presentation.
As those reserves dwindle, the PBOC may be forced to devalue the currency, according to analysts at CLSA.
As Federal Reserve interest-rate increases buoy the greenback, defending the yuan will cut China’s currency reserves to less than $2.75 trillion by the middle of next year, said Amar Gill, head of Asia research at the brokerage. That will prompt the nation to move to a free-float regime in the second half, he said. CLSA forecasts that the Chinese currency will slump to 8 per dollar by the end of 2017, a weaker level than any of 44 other analyst projections tracked by Bloomberg. The median estimate is for a 3.7 percent decline.
If you think this sounds like a vicious cycle, you may be on to something.