What Will China Dump Next, After Treasuries, to Keep Control?

“Practically boundless” future capital outflows.

“Beneath all of the financial turbulence there lurks, in my view, a credit crisis; I fear the worst now,” UBS economic adviser George Magnus told Bloomberg TV today. The reform agenda “has stalled,” he said, and “things are looking much bleaker for China going forward.”

And so on Monday, we got another flavor of it.

The Shanghai Composite index plunged 5.3%, to 3016, down 15% so far this year. The Shenzhen Composite fell 6.6%. Hong Kong’s Hang Seng fell 2.8% to 19888, below 20000 for the first time since June 2013, and down 30% from its April high.

Everyone had hoped that China’s “National Team” would jump into the fray and bail everyone else out, but it didn’t. And the People’s Bank of China didn’t offer any big new remedies either. But it did stabilize the yuan after it had dropped 1.5% against the dollar last week, and about 6% since mid-August.

In Hong Kong, interbank yuan lending rates broke all records since the Treasury Markets Association started compiling the data in June 2013, with the overnight Hong Kong Interbank Offered Rate spiking 939 basis points to 13.4%.

And copper did it again, ratting on China’s real economy. Copper goes into anything from skyscrapers to smartphones. China is the world’s largest copper consumer, accounting for over 40% of global demand. And on Monday, copper dropped 2.6% to $1.97 per pound, the lowest level since May 2009.

Buffeted by, among other things, fears about slowing demand from the industrial sector in China, oil plunged – with WTI down 6.1% to $31.13 a barrel

To prop up the yuan and counter the impact of capital flight, China had dumped $510 billion of foreign exchange reserves last year, drawing them down to a three-year low of $3.33 trillion. And that was just the beginning.

According to estimates by BofA Merrill Lynch, that $510 billion of sales included:

  • $292 billion of US Treasuries
  • $92 billion of US stocks
  • $3 billion of US agency debt
  • $170 billion of non-US paper.

But China also increased its purchases of US corporate bonds by $44 billion, bringing the total to $415 billion.

So what is China going to dump next? The New York Times cites Shyam Rajan, rates strategist at BAML: “In the next two months I would still say Treasuries. But if the pressure continues beyond that, it’s non-US assets, and in the US space it’s definitely corporates and agencies.”

In the report, BAML estimated that China still holds:

  • $1.29 trillion of Treasuries
  • $1.15 trillion of non-US assets (mostly short-dated euro-denominated bonds)
  • $212 billion of US agency debt
  • $415 billion of US corporate bonds,
  • $266 billion of stocks.

Selling a significant part of its $415 billion of US corporate bonds and $266 billion of stocks will likely leave an imprint on the markets. And selling $500 billion or more in assets a year when the total stash is down to $3.3 trillion, well, pretty soon it becomes apparent that this cannot be done for a long time before markets realize that it cannot be done for a long time, and then, when confidence collapses, things could get a little hairy.

It’s getting complex already. By dumping its FX reserves, China is trying to counteract the impact of capital flight. Fitch Ratings reported today that capital flight since the second quarter of 2014 is by now “likely to have exceeded” $1 trillion. In light of that kind of number, those $3.3 trillion of foreign exchange reserves don’t look that huge.

Analysts at JPMorgan Chase reported that the causes of these capital outflows have grown more numerous and “have entered a new phase” in the second half last year, “broadening to include foreign direct investment and portfolio instruments, something that could make future capital outflows practically boundless.”

And this, according to Fitch, is getting China’s policies tangled up in some unsavory contradictions:

China is facing a sharpening dilemma between a perceived need to keep interest rates low to help the economy manage its debt burden, and downward pressure on the Chinese yuan and foreign reserves.

The authorities have reduced interest rates steadily since November 2014 in a bid to help the economy manage its debt burden – which is high and still rising – at a time of slowing growth. However, lower rates are helping to drive capital outflows, weakening the yuan.

So China is selling its FX reserves to prop up the yuan. But….

A country cannot simultaneously allow free capital flows and control its exchange rate and domestic interest rates. This is at the core of the policy dilemma China faces between the imperative of keeping rates low for domestic stability against pressures on external stability as exemplified by the exchange rate and reserves data. China still operates capital controls, but the scale of flows suggests that these have become porous.

And that coming massive yuan devaluation everyone is talking about? Maybe not. Because it might just be the trigger that would set off a nasty chain of events:

Fitch does not expect the authorities to resolve the dilemma with a large trade-weighted yuan depreciation, as this would risk creating additional uncertainty and further undermining policy credibility….

Because “policy credibility” is sacrosanct. Losing it would be the nightmare scenario. It would signal to the markets that the authorities have lost control entirely over the currency, the credit markets, the stock markets, and all the things they’ve been trying to keep from unraveling. And this would start the unraveling in earnest.

“Now is the right time for us to sell this investment,” Deutsche Bank’s co-CEO John Cryan said to justify the sale of Deutsche’s stake in Hua Xia Bank in China. He couched the deal in all the right terms. Other megabanks too have been dumping their stakes in Chinese banks. Read…  What Secret Do Global Banks Know about Chinese Banks?

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  35 comments for “What Will China Dump Next, After Treasuries, to Keep Control?

  1. Gian says:

    June 1, 2009, Chinese students laugh at Tim Geithner (“the tax cheat”), assuring them of the strength of the U.S. dollar as an investment. It is beginning to look as though the U.S. will have the last laugh!

  2. Vespa P200E says:

    I heard the interview with Kyle Bass Fri. He stated that “if China’s banking system loses 10%, you are going to see them lose $3.5 trillion.
    He then puts this number in the context of China’s “massive” foreign reserves of about $3 trillion”

    So Chinese CB in tailspin may be forced to tap into the huge foreign reserve as they need more ammo for their PPT (plunge protection team) and the MOST liquid assets may be the US Treasuries.

    Alas – who will buy/mop up what the Chinese and their “mystery” Belgian fat fingers will unload with skewed supply forcing higher rate way beyond Janet’s 0.25%?

    • Mr. Y says:

      Probably Japan, and the rest of the usual suspects.

    • CrazyCooter says:

      What Kyle was really getting at is that China’s banking system has grossly outstripped its underlying economy – sort of like what happened in Ireland and Iceland.

      So, even modest moves have huge nominal values that have to be eaten – so the ForEx pile isn’t really big when put into context.



  3. NotSoSure says:

    I think there will be a rally soon, so that China can dump stuff.

  4. CrazyCooter says:

    If I am reading this correctly, that overnight inter-bank lending rates shot up over NINE PERCENT … overnight … then TSHTF … in present tense … if rates stay at these levels for any period of time.

    Correct me if I am wrong, but inter-bank lending is EXTREMELY important to fractional reserve systems – here is why.

    In practice, leverage in a fractional reserve system is UNLIMITED if the system is CLOSED. Reserves DON’T matter – banks lend if they are either greedy or think they will get paid back.

    How this works is that a great loan walks into a bank (Bank Alpha), but Bank Alpha is maxed out per their reserves and loan book – they can’t make the loan without exceeding their mandated limits. So Bank Alpha makes the loan anyway and just borrows additional reserves from another bank. Since the loan being made conjures up new money, that money HAS to deposit somewhere, so the reserves are guaranteed to be there to borrow. In this case the borrower banks at Bank Beta, who then has a huge pile of reserves from the new deposit, and lends them back to Bank Alpha that made the original loan.

    Neat, huh?

    A low rate for this inter-bank borrowing means banks are expanding lending and trust the other banks to pay their reserves back, at interest. At this rate starts to go up, it means the banks don’t trust the other banks and want more compensation.

    Let’s say Bank Alpha made this loan at 8% and borrowed the reserves at 4%, making a nice 4% spread. As the inter-bank rate goes up, the spread gets smaller, but at some point, like what we are seeing here in the OP, banks are LOSING money when they borrowed reserves to expand their balance sheet. This will detonate a bank, that doesn’t have its own reserves, very quickly – especially, since this is an overnight rate, other banks call their loans or refuse to roll the inter-bank lending (thus higher rates).

    And guess what happens when one bank detonates …

    I went looking for a chart and to be clear this is the CNH-Hibor, Yuan based, not the Hong Kong Dollar based rate, but still it is insane for an overnight move. FT has a good chart:


    There is definitely some cyclicalness to this, and I don’t think this is end of quarter window dressing … maybe this rides on as the chart indicates it has been doing since August, but at the same time things are rapidly getting ugly in China from the news I have been seeing here and elsewhere.

    Anyone with working knowledge of this rate and or the goings on in the interbank lending market over there?



    • CrazyCooter says:

      Er, stupid FT. If you search the article title on google, they will allow you to pass directly to the article.

      Google search:


      Here is the Google link:


      This is the chart:


      I tested the links, but missed the FT paywall bit going through google.



    • ejhr2015 says:

      I’m no expert on banking but I do know that fractional reserve lending is no longer practised. It was superceded, I don’t know exactly when, by the Credit Creation theory. This has been endorsed by the BoE, so it’s no myth.
      All banks have to do is stay solvent and they have no other constraints on how much credit they can create except customer numbers.
      Can you check this against your blog?
      It might need adjusting?

    • EB says:

      Cooter and Wolf :

      I’m concerned that the exorbitant increase in the Hong Kong intra-bank lending rate developed in response to massive losses (possibly defaults) in the Chinese property market. Hong Kong banks are the primary lenders for the Chinese property market, and a precipitous collapse in that market would offer a viable explanation for the sudden and dramatic increase. Foreign investment in the property sector is estimated at $1 trillion, and British, Japanese and American banks also have exposure.

      The Chinese Banking Regulatory Banking Commission (CBRC) reportedly met in September with senior executives of foreign banks regarding non-performing loans. The CBRC issued a statement declaring that “the current situation is more severe than the time in 2008 during the financial crisis.”


      • CrazyCooter says:

        I had a great smart *ss comment on the ZH thread I linked (I am starting the Mexican Dog trading meme – help me out LOL), but this is a deeply complicated short term trade move by the Chinese CB (if I understand it correctly). I do pretty OK with macro stuff on longer time lines, but when things get nutty for short term, technical reasons I am simply out of my league.

        I don’t do this for a living, I just find it fascinating and read as much as I can as I enjoy the learning process (at least for now). I am very small in terms of investing and have odd “investing” behaviors with lots of seasoned reasoning – but maybe I am wrong.

        If folks don’t like my macro commentary, please butt heads (ultimately it is why I post), but this is not something I can add too much anymore – and I hope y’all respect that.

        In college I had a “money crisis” class which was a top level series with a good professor. As best I can tell, this is the same song and dance routine as the world has seen over and over – massive credit expansion followed by a massive bust. Minsky is your go-to if you gotta read up (or manias panics and crashes by kindleburger – google for the audio book as it is a very old publish). These things have destroyed nations in the past. They last until they don’t – no one can time them, even their masters. It just happens, always for a reason, and someone will have chips down when it does and everyone will think they are a genius. But you can’t learn the timing in class or in a lab – it is just a good part luck and a good part doing one’s homework – but luck is still a big factor.

        My feel is that all the CBs are tied together – so if a big one goes down – and China is in that league – it is going to absolutely wreck everyone else because it is going to spread. I feel this is already in progress, but it is slowed and is taking years – folks don’t notice it as much as a result. Yet, even with this in mind, CB actions are less harmonious than they have ever been in modern history (i.e. the last 100 years or a bit less). Just look at the Swiss CB move. US brokerages cancelled trades in a fuss – someone big and inside needed to cover naked shorts – and they just flat out screwed folks that had good, in-the-money bets. Just my take. Not unlike MF Global.

        More of that is coming. And at some point, they are going to screw over businesses that need their short term lending facilities to make payroll or purchase raw inputs from abroad – and that is when things are going to get real.

        The house is burning down, and we might still be having this conversation in a year, but it is still burning down.

        One last closing comment. There is an expression from where I grew up that went along the lines, “You will always know where you are going if you think about it before you start.”

        Folks should start paying very serious attention to where things are going and starting considering the wisdom of that expression.



    • Petunia says:

      I worked electronic fund transfers for the NY branch of a really big Asian bank a long time ago, CHIPS/SWIFT. The system then was that our trading desk would inter-bank borrow at the end of the day to make sure we cleared all transfers. If we couldn’t borrow from other banks, then we borrowed from the fed, who was the lender of last resort. Borrowing from the fed was avoided at all costs because it was followed by the bank examiners. Avoiding the bank examiners was worth any price (interest rate) offered by another lender.

    • Chicken says:

      Given bankers are self-accliamed sleeze balls avoid of moral, Libor/Hibor are curiously low.

  5. B Tilles says:

    Looking for simplicity in a complex world I have a slightly different, albeit not very nuanced take on China in general. When they were booming they exported inflation. When they contract they export deflation.

    • CrazyCooter says:

      With the caveat that this is a “two way street” in the sense that they push/pull with any given partner who also pushes/pulls back. This is the whole ForEx mess where one tries to manage whether push or pull is the winner or loser against all possible currency relationships … where some are more significant than others.

      Said differently, if the US exported massive inflation and China exported massive deflation, what would US or Chinese customers experience? Flip that notion around however you like and try to sort it out.

      While this may not be intuitive, I think the whole world is deflationary … sort of all elevators heading to hell, but they do so at different rates … so you look at the elevator across the way and go “gosh, they are going faster” or “gosh, they are going slower” … and relative to your own elevator draw some conclusion about your lot in life … but the speeds aren’t constant … except the direction (i.e. they are all on an express trip to hell none the less).

      Feel like you are walking stairs in an Escher drawing yet? :-)



      • polecat says:

        Ha!….I feel like those black/white geese flying in formation, opposite to each other………..confused on which way to turn!

  6. Uncle Frank says:

    RBS cries ‘sell everything’ as deflationary crisis nears

    “China has set off a major correction and it is going to snowball. Equities and credit have become very dangerous, and we have hardly even begun to retrace the ‘Goldlocks love-in’ of the last two years,”
    – Andrew Roberts, RBS credit chief


  7. michael says:

    If china is in trouble where does that leave the US? The ass-hats in Washington are spending with reckless abandon. If you don’t believe their will be a reckoning you are not thinking.

    • CrazyCooter says:

      The welfare checks stop cashing – at some point. As a broad generalization, no one cares until that happens. Go check the numbers on the growth rate of disability, medicare, SNAP, etc.

      I have a very distinct memory from childhood (in Texas). I messed with an ant mound, playing around with a stick – thought I was boss – and eventually realized a bit afterwards I was covered in ants. I stripped damn near butt *ss naked in nothing flat it scared me so bad (not to mention more than a few stings – but far too late).

      Your mileage may vary.



  8. Nicko says:

    The answer is massive immigration from developing nations to developed ones. Developing nations will add over two billion people over the next Thirty years; one billion in Africa, another billion in Asia ( mostly Pakistan, Indonesia, India, Philippines). Similarly, an increase of FDI to these emerging economies will benefit from brisk growth (average 5%).

    • prepalaw says:

      That would be total insanity. Importing useless eaters, when automation is going to destroy more than 40% of existing jobs in the next 20 years – most of those jobs are low to semi-skilled.

      • MC says:

        I fully agree with your sentiment, albeit I believe we’ll see a desperate rearguard action once government realize human workers (who pay taxes and buy stuff on which taxes are paid) are being replaced by software and robots (who pay no taxes and buy nothing).
        However, the insanity has already taken hold and it will be very hard to undo. Most countries are still stuck in the “cheap labor” mentality, meaning they believe the main growth engine is dirt cheap labor. Germany is especially guilty here, considering it’s home to some of the largest industrial groups in the world which should know better than going along a scheme to import more unemployable people.
        Not only they know very well their Japanese and South Korean competitors have been investing in automation like there’s no tomorrow, but I am pretty sure they have on their tables confidental reports highlighting what Chris put so well in his post: as the world population starts shrinking and aging, demand for everything, from chainsaws to light bulbs, will decrease.
        And to make less stuff, you need less people, robots or not.

  9. Ptb says:

    USD investments hav paid well the last year due mostly to the forex. When in trouble, one sells what there a market for buying. So, there you have it.

  10. prepalaw says:

    China has no foreign debt. In my opinion, the Chinese Authorities are engaging in one big “face saving” operation. No one within China should question if the Government has lost control. It will not impact me if they decide to consolidate all bad Chinese banks, shoot 10,000 bankers and speculators and start over with new banks.

  11. chris Hauser says:

    um, sounds like a cash call in china.

    best just to keep moving.

  12. Chicken says:

    Growth is environmentally unfriendly, by definition. The Myans would be proud of this scale of blood letting.

  13. Boris says:

    Wolf –

    There are occasional rumblings in the Asian press about the coming Chinese Gold Price Fix. Some say it will happen this coming April. Seems to me it has to be much farther down the road. What is your perspective?


  14. Jeff says:

    Every time I hear about China’s financial condition I cringe because I feel it pales in relation to the western nations….. Who has the greatest debt ? We’re talking about Chinese banks when US banks have been bankrupt since ’08 if you care to look at the books.
    Forgetting all the #’s if all paper becomes worthless worldwide who is in the best position ? How has the gold ? Stockpiled oil and commodities ? Holds paper (Treasuries) to all those loans ? Has the greatest manufacturing base ?
    I believe this is all part of the plan and power will again move eastward. While the US stands with nothing in their hands but worthless paper and debt.
    That’s why I cringe……. Like the pot calling the kettle black.

  15. Jeff says:

    China’s is in such a bad state they are buying all the gold (and oil) they can get their hands on. All with worthless paper (treasuries). Imagine that. [ http://www.bloomberg.com/news/articles/2016-01-13/china-imports-record-crude-oil-as-price-crash-accelerates-buying ]

  16. Michael Mears says:

    who is buying all of the US paper being sold by China? Why are US interest rates not rising in the face of all of these US paper being sold?

    • Wolf Richter says:

      QE is still raging in Europe and Japan, where yields are much lower. Emerging Market debt is in turmoil. Investors are fleeing those places to earn 2.1% on 10-year US Treasuries. They’re HOT!

      • d says:

        The issue with this whole CNY thing.

        How many 100 CNY notes are really in circulation 10, 50, 100, Trillion, more than they say?

        When Truckload’s (Proper box bodied Truck’s) of cash, are recovered from 1 corrupt generals house, something is wrong with the circulation numbers.

        They are literally clandestinely printing CNY to buy up gold, and the west.

        Their commodity stockpiles are huge and growing, obtained the same way.

        They “Lost” a whole warehouse full of Aluminum ingots, that had been used to its 100% security value, multiple times, to multiple finance entity’s. Some of whom where American. They have simulacra issues with the same copper being used to secure multiple loans to multiple banks although the copper was still around with ten banks fighting over who owned the security on it. Never really heard the end of those deal’s.

        More importantly, how do you “LOOSE” a whole Warehouse full of aluminum Ingots?

        When it finally come out how much CNY is really out there. The west, not china, is going to be holding the baby. As their CNY holding will be worth perhaps .1% of what they are booked at.

        The first 2 thing’s to remember “They invented” paper money, and THEY, wrote all the dirty tricks that go with it. When westerners were still bartering bronze for: dogs, hides, horse’s, and grain.

        The only reason we caught up, is for some stupid reason the do not value Mathematicians, in a scientific computerized age.

  17. Mikef says:

    At the end of the story, unless the Chinese have a revolution, as the prior comment states, they may collapse temporarily, but they still hold more and more of manufacturing facilities. U.S. manufacturing is getting gutted or rather what little remains is being gutted. Jobs and opportunity will be with their people, not U.S. generations.

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