What If CNY’s Backdoor Still Isn’t A Big Enough Exit?

China’s currency had been on fire for seven months straight. Rising nearly in a straight line, from May 27 last year until very early January this year, CNY had gone from a certain plunge into the devastating monetary abyss (unintentional devaluation) to a significant basis for Xi Jinping’s global boasting. This was no ordinary turnaround.

The timing of it speaks initially to underlying fundamental economics: reopening globally which just got things moving again. Dollars that were denied via both the merchandise and financial (“hot money”) channels became available, or at least relatively more available than they had been in March and April 2020 (GFC2). Some have spoken of, and continue to talk about, a flood of currency worldwide.

Reopening and some stature of a rebound, sure, there has been a glaring omission so far as the Chinese part of it has been concerned; where did these inbound dollars end up?

The only thing we know for sure is where they didn’t materialize, which just so happens to be the one place they really should have. Dollars (or other foreign currency; primarily dollars, though) enter China and the PBOC scoops up a significant portion of them as soon as they do (managing the exchange rate’s float). Historically, it had been a near dependable, almost proportional relationship:

The more “dollars” the eurodollar market had to offer the Chinese – especially in the aftermath of GFC1, or Euro$ #1, when it was assumed EM’s like China would escape the lingering problems becoming more apparent in the DM world – the higher CNY traded (after being allowed to limited float) because they were plentiful to the point of competition to lend them. What the central bank didn’t need, the rest went on to China’s domestic banking sector.

Since the world runs on a (euro)dollar standard, these “dollars” get recycled back into the corporate sector for re-use in global trade (as well as other financial forms); through specific intermediaries such as the Import/Export bank, through offshore interbank markets, or as “dollar” loans taken out by China corporates from China domestic banks.

More importantly, so far as the central bank is concerned, these forex assets which had previously accumulated on the PBOC’s balance sheet formed the basis for internal RMB money. Essentially, the monetary authority “converted” those “dollars” (which it would invest in UST’s) into RMB bank reserves and physical currency. China money is significantly dollarized.

That transformation gave the PBOC further monetary control over the domestic banking system, including reserve requirements (RRR) acting as its margin for error when fine-tuning bank reserves (which before Euro$ #3 had been expected to only be in the one direction).

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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