How a reduction in China’s reserves will create US Jobs
By JC Collins
The reduction in China’s foreign exchange reserves is a good thing. In fact, back in 2013 the People’s Bank of China Deputy Governor Yi Gang said, “It’s no longer in China’s favor to accumulate foreign exchange reserves.” This has also been echoed by PBoC governor Zhou Xiaochuan who has previously outlined the banks strategy of ending foreign exchange interventions and allowing the renminbi to float freely on the foreign exchange markets.
This position stands in stark contrast to the loud proclamations of some sites and news sources which state that a reduction in Chinese foreign exchange reserves is proof of an imminent collapse in Chinese markets and banking sector.
The monetary dynamic between China and the United States dollar has been a well-maintained and thought-out strategy. The two-country and two-currency model of monetary intervention policies served the purpose of the broader and more macro-economic framework of the unipolar dollar based system.
Now that the need for a unipolar system has been reduced and the need for a multilateral and multi-currency system has grown, the same monetary dynamic will be used to reverse the large foreign exchange reserve accumulation which had previously supported the US hegemonic framework.
The recent increase of interest rates by the Federal Reserve has forced China to respond in a similar fashion. The parallel interest rate dynamic between the Fed and the PBoC is forcing the exact response which has been planned. It has forced the PBoC to intervene and maintain the structure of the existing dollar peg by reducing foreign exchange reserves.
It should be noted that China will remove this exchange rate structure and dollar peg when the time is right to do so.
The easiest method to understand this dynamic is by grasping the interest rate parity mechanics which exists between the renminbi and the dollar. When the US increases interest rates the PBoC most do the same thing. This causes stress on the Chinese credit markets.
But it also means that any appreciation in the US dollar will also mean an appreciation in the renminbi. Considering that Chinese foreign exchange reserves are mainly denominated in the US dollar, any appreciation in the RMB will mean a depreciation in the foreign exchange reserves.
Though the reduction and substitution of these reserves is the end goal, Chinese monetary authorities must be strategic and patient in the pace of the reduction. Which is why the recent intervention policy by the PBoC has stage managed the daily fixed rate of the renminbi against the dollar and slowed the pace of reserve reduction and sell-off.
China will be unable to fully end the dollar peg until such a time as the foreign exchange reserves are reduced to a level which can both facilitate and support the full internationalization of the RMB and its appreciation on the foreign currency market.
The give-and-take slow bleeding of dollar liquidity in the Chinese markets must be carefully orchestrated as deleveraging too fast will cause a hard depreciation of the RMB, while deleveraging too slow will cause a slow collapse of China’s domestic credit market.
As such, the PBoC’s monetary policy independence is directly anchored to the Federal Reserve’s monetary policies. The implication of this framework and dynamic is that China may not be as free to dump dollars and wage economic warfare against America as some others have suggested.
In the post How China is Deleveraging from the USD I wrote the following:
“It is always possible that American strategists could attempt to play with this pacing and sequencing in attempts to further weaken China’s domestic financial market. It is also probable that China is aware of this and has placed its own not-so-obvious mechanisms to prevent a larger volume of capital flight than would be expected.”
“It is estimated that China’s foreign exchange reserves dropped by just over $500 billion in 2015. The current level of foreign reserves now stand at $3.3 trillion. It would be my conclusion that Chinese authorities are “deleveraging” these reserves down to the $300 billion range over the next two to three years. This will take place, as described above, through RMB internationalization, and the selling of USD reserves for RMB.”
“It is also important to understand that the RMB internationalization, being the increase of renminbi denominated financial products offered to foreign banks and institutions, will help offset the domestic influx of renminbi. This will reduce the chances of unwanted inflation and facilitate the coming appreciation of the Chinese currency.”
In that post we also reviewed the improbable strategy of China dumping US dollars as a method of economic warfare on America. This would damage China as much, if not more, than it would the US. It would cause a massive influx of renminbi into the Chinese economy which would lead to massive inflation and the collapse of the domestic economy.
The more we learn about this monetary transition the more we can begin to see that the US monetary and geopolitical strategists have been busy positioning American interests. A reduction of USD denominated foreign exchange reserves will allow America to depreciate the dollar and increase exports. It will also allow them to once again put domestic needs before international needs.
This monetary transition does not signal the end of American prominence. In all probability, it could signal the beginning of a new American century of growth and prosperity. A prosperity which will be shared around the world as the imbalances in global wealth are corrected. This is the framework which will see the world model encompass new technologies and bridge new roads into the future. – JC
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