China: RMB no longer a free lunch (IV) - nor is the market!
Summary
Nearly a month ago we gave you our impressions as to why the RMB is no longer a "safe" one-way bet: there are plenty of reasons suggesting that it actually may stall, if not weaken over the next few months. Today we refresh these ideas with more recent news bits, tying this in to our earlier comments on China's lending and markets outlooks.. We also allude to our recent piece in which we linked US government bond yields to what Beijing may do with some of her holdings of American bonds.Topics Covered
- Misleading lending data
- RMB tug-of-war revisited
- How to make money off this idea
Background
1. Misleading lending data
Earlier we warned you that "strong" lending figures in China - a key reason that propelled the market up of late - are misleading. Our view was vindicated in the South China Morning Post (SCMP) of 14th March, page B1: "Bankers' confidence falls for second quarter amid loan surge". What the journalist said was that a key reason for the recent surge in lending has been a huge jump in "bills financing". What is "bills financing"? The journalist explains: "In such lending,a bank assumes a firm's bill, guaranteed by a second bank to a buyer, before it is due and credits the bill's value after a discount charge to the client's account." So basically, "bills financing" is just a guaranteed cash advance against imminent payment.
That kind of lending clearly is not stimulatory to an economy: firms just get their money a little earlier.
Moving beyond this technicality of stronger lending due to bills financing, the journalist also points out that with more bank lending occurring in other areas (e.g. in longer-term credits), any form of credit assessments gets laxer. So lending gets riskier.
All of which suggests that the strong lending data which you read about is not quite as wonderful as some market bulls wish to believe....
Besides which, remember that all market strength in China is derived from policy moves - NOT from good economic data. So the market moved yesterday in Shanghai because the Central Bank may cut reserve ratios. That is fine - but have you stopped to think just why they may be contemplating this? Were "things" so strong, surely they would not need to cut ratios, would they? Buyers of markets, beware - or be very attuned on a short-term trading basis regarding your exit strategies...
Buyer of markets, beware!
2. RMB tug-of-war revisited
What does "strong" bank lending have to do with a weak RMB? Everything! Their common denominator is "stimulating the economy". Lending is meant to boost corporate liquidity, and a weaker RMB is meant to boost exports.
Two pressures on the RMB have arisen this week. First, the innocuous statement in said SCMP elsewhere, that "China will allow more foreign institutions to trade foreign currencies in the country..." This means that China very slowly is allowing her capital accounts to open, and that means that people in China will wish to exit the RMB and buy hard currencies that are backed by relatively safer banking systems... So, this news of allowing more forex trading in China suggests increased downward pressure on the RMB.
That downward pressure on the RMB, of course, is being driven very much by local politics in China. Not only are her local politicos fighting huge unemployment problems; furthermore, they, too, wonder why they must kow tow to US politicians' short-term demands to re-value the RMB. Instead, China's domestic politicians want Beijing to devalue, not revalue the RMB!
Meanwhile, American politics are creating more upward pressure on the RMB. Just last Thursday, 12th March, designated US Trade Representative Ron Kirk vowed to conduct yet another "currency review" of the RMB: he will research whether China's currency practices are consistent with Beijing's promises to the World Trade Organization.
This report will be released in the middle of April, i.e. in a month. We all know what this will entail: China will get chastised yet again for an "undervalued" RMB. The Chinese will retort that they "could" sell off their massive holdings of US bonds - but that only would drive down the value of their own holdings, thereby propelling US long bond yields.
Ultimately, what you will see is a political tug of war: China's politicians will urge Beijing to devalue the RMB, and America's will urge China to revalue. The bottom line is going to be political tension, none of which can be stimulatory for the Chinese economy.
This suggess that recent strength in China's stock markets is going to get hurt yet again.
3. How to Make Money Off This Idea
- Always consult your financial adviser first.
- Buy the ETF which shorts the Chinese stock market, FXP:US, if you agree with us that China's economy and thus earnings is/are not as strong as markets wish to believe.
