2015-01-29

Will China Devalue or Deflate?

Two articles out today discussing the impact of devaluation on the stock market and real estate, along with the PBOC's new worry: capital outflows.


iFeng: 从人民币贬值看2015房地产与股市 房价泡沫如何应对?

Quick summary: Currency devaluation will pull hot money out of China and its real estate sectors. Imports will rise and cut disposable income. Should the government need to defend the yuan, it will need to sell dollars, effectively pulling liquidity out of the Chinese monetary system.

Under the context of currency fluctuations, the exchange rate mechanism of the fall in house prices mainly covers three effects: First, the liquidity effect. Devaluation of speculative capital will compress profit margins, prompting capital outflows, causing the flow of domestic real estate funds are tight, and then change the current supply and demand of real estate. In the same amount of real estate supply conditions, due to lack of funding and support demand, real estate prices will be suppressed impulses. Followed by reverse wealth effect. Devaluation would cause prices of imported goods rise, leading to reduction in imports, resulting in domestic commodity prices, making society less purchasing power, resulting in weak consumer demand, real estate, eventually forming a downward pressure on prices. Finally, the substitution effect. In devaluation or a depreciation of the expected conditions, the government in order to maintain a stable exchange rate will be market intervention by the release of US dollar buying yuan boosting its currency, which would result in lack of liquidity, curb real estate prices.

The article goes on to discuss the stock market:
Under the context of currency fluctuations, visits from the transmission mechanism, without considering other factors, devaluation will put downward pressure on the stock, the RMB exchange rate is mainly affected by the following two paths A-share market: on the one hand, the exchange rate expected by the impact of transnational capital flows, thereby affecting the inflow of A-share market, the amount of money, and ultimately to the regulation of liquidity to influence stock prices, both of which have the same tendency to change; on the other hand, the currency exchange rate fluctuations through open market operations and the adjustment of interest rates and other government macro-control policy means, thereby affecting the amount of money in circulation and the financing costs of the capital market, and thus lead to fluctuations in stock prices. After that exchange rate depreciation, government demands for the stability of financial markets, the use of monetary policy interventions, such as raising the deposit interest rate will result in social capital flock to the bank, down the supply of social capital, the formation of the downward pressure on the stock. In addition, due to the rise in lending rates will lead to increased financing costs, and thus corporate profit margins shrink, will put downward pressure on the stock.

The article hints at the catch-22 faced by Chinese policy makers. In a slowdown scenario, defending the yuan is deflationary. On the flip side, easing measures by the central bank will weaken the yuan. The takeaway is this: if there's a serious slowdown, China will not defend the yuan.

iFeng: 人民币贬值:资本流出成中国央行新忧 增强对宽松政策的需求 (Yuan Devaluation: Capital Outflows Become PBOC's New Worry, Increasing Demand for Easing)
Chinese central bank governor Zhou Xiaochuan served in 12 years, one of the problems most of the time his biggest headache is how to deal with the influx of large amounts of capital in this fast-growing Chinese economy. Today, the capital outflow has become a concern. As the dollar strengthened, the yuan under pressure, pushing the yuan exchange rate floating range of low-end approaching, but the challenge Zhou maintained its position determination. In addition, the anti-corruption movement and the worsening economic outlook prompted investors to consider draining money from China.

Chief economist at Mizuho Securities Asia in Hong Kong, said Shen Jianguang, now, bear further depreciation of the renminbi pressure, which will lead to more capital outflows; these two factors may enhance each other, bringing demands for a more relaxed monetary policy .

In order to prevent the loss of mobility caused further economic slowdown, China's central bank may need to further increase the intensity directional injection, or cut banks' reserve requirement ratio or interest rates. China's economy in 2014 hit a 24-year slowest growth. On the exchange rate , China's central bank currently seems to respond to pressure to devalue.

RMB January 26 its biggest two-day drop since 2008, China's central bank raised its daily central parity of RMB exchange rate.

Everbright Securities Gao Xu, chief economist in Beijing, said the central bank told the market, it will not let the yuan suffer a big devaluation; China faces capital outflows is mainly caused by a stronger dollar, once the dollar momentum dissipated, capital outflows situation will be eased.

The assumption that easing will help the yuan is based on the idea that easing leads to faster growth. If easing doesn't lead to growth, if China is facing a credit cycle and demographic slowdown, then a series of rate cuts are coming before the economy bottoms out. Another assumption is an end to U.S. dollar strength, as in the argument put forth by Gao Xu, but the dollar is more likely in the early phase of a bull market.

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