Currency Reserves

Trump’s tax cut has not, to date, unleashed a wave of global demand for U.S. dollar assets. In fact, the dollar weakened as prospects for the tax cut—and associated rise in the U.S. federal budget deficit to over 5 percent of U.S. GDP—increased. And it has depreciated further this year (and even more today). It seems like the best explanation of the dollar’s weakness is the unexpected strength of the entire global economy right now—and in particular the strength of Europe’s recovery. Just as the dollar moved up in 2014 in anticipation of the Fed’s policy normalization, the euro seems to be strengthening on expectations that the ECB might actually need to tighten in 2019. Any exchange rate reflects developments abroad as well as developments at home. Or to make a more technical argument, if the scale of the ECB’s asset purchases was driving a lot of funds out of the European fixed income market and into U.S. bonds, the reduction in the ECB’s pace of buying (which the ECB would no doubt describe as ongoing easing just at a slower pace, as its balance sheet continues to rise) might also have an impact (though the connection between flows and price moves is complex, see Coure's speech at the IMF's research conference). The dollar was certainly on the move even before Secretary Mnuchin's comments today. All this said, I certainly didn’t expect bigger fiscal deficit and a tighter monetary policy as the Fed started to reduce its balance sheet and continues to raise policy raises to combine to lead the dollar to fall. I don’t claim to fully understand the reasons for the dollar’s current weakness. No matter. It has become clear over the past few weeks that most of the world—at least those parts of the world with large current account surpluses—like the dollar more or less where it is, and do not particularly want it to weaken further. They are, as a result, resisting—in various ways—a currency move that would bring the world’s trade into better balance (reminder: U.S. non-petrol exports responded in the way that one would expect given the dollar’s 2014 appreciation, and subsequently have underperformed global growth). Last week, Europe—meaning parts of the ECB—did a bit of soft verbal intervention. Various members of the ECB’s governing council highlighted that a stronger euro would make it harder for the ECB to achieve its inflation target, and thus hinted that further currency moves might lead to a delay in any ECB tightening. Fair enough. But if the Eurozone accepted a stronger currency and offset the drag on both exports and inflation with a more expansionary fiscal stance, it could simultaneously move closer to both external and internal balance. The eurozone now has the tightest fiscal stance—judged by the size of the structural fiscal deficit—of any of the world’s big economies. There is certainly scope for the largest and most export-driven eurozone member-state to offset the impact of a stronger euro with a bit of demand support. Germany's fiscal surplus is heading to over 1.5% of its GDP absent policy changes from a new government. And the reaction in Europe has been mild compared to the reaction in Asia. Almost all the big surplus economies in Asia—with the notable exception of Japan —appear to have intervened to keep their currencies from appreciating against the dollar in the past few weeks. Korea is the most obvious case—it jumped in loudly to keep the won from strengthening too much, and looks to have drawn a new line in the sand around 1060 won to the dollar. But it isn’t alone. China doesn’t seem to want the yuan to be all that much stronger than 6.4 yuan to the dollar—though there isn’t (yet) hard evidence of intervention, and the yuan did move a bit beyond 6.4 today. While Taiwan hasn't defended 30 NTD/USD since late December (to be fair, Taiwan’s central bank maintains the private demand for dollars just happens to surge at about that level), it does seem to have resisted pressure for the Taiwan dollar to strengthen much beyond 29.1 to 29.2 earlier this week (or it just happened that private demand for dollar rose at this level). Thailand—which now runs a current account surplus of around ten percent of its GDP—unquestionably has been intervening, though it seems more to smooth the baht's appreciation than to completely halt it. Thailand releases weekly reserves data, and its combined reserve and forward book jumped by $4 billion in the first two weeks of the year (valuation changes could explain perhaps $1 billion of the change). I will have more on the details of Asia's intervention soon. But before going into individual cases, I wanted to highlight the big picture: A lot of Asian countries with big external surpluses remain ready to step in and keep the dollar from depreciating against their currency. And in the process they block market pressures that might otherwise bring the U.S. trade deficit down. This of course isn’t new. The same thing happened when the dollar floated down against the euro in 2003—Asia initially more or less followed the dollar down, thanks to a surge in intervention. And it happened again when the dollar was under pressure to depreciate in 2009 and 2010 (in part because the ECB kept its monetary policy far too tight back in 2009, 2010, 2011, and 2012, adding to dollar weakness). Basically, when the market wants to fund the U.S., the U.S. historically has accepted the inflow and the stronger dollar—and when the market doesn’t want to fund the U.S., many of the world’s surplus countries have tended to step in and resist the appreciation of their currencies and in the process finance bigger ongoing U.S. trade deficits than the market wanted to fund. And I see some early signs that this process is repeating itself. Basically, the market is now creating pressure to bring the U.S. trade deficit down (which, by implication, means the rise in the U.S. fiscal deficit would need to be funded domestically). But the world's big surplus countries also need to do their part with policies that help rather than hinder global adjustment. Otherwise I worry that the market pressure for trade adjustment will fade —and the pressure for a bigger trade deficit created by the rising U.S. fiscal deficit will come to dominate.*   * I have long believed that the dollar's 2014 rally left the dollar too strong for the tradeables sector of the U.S. economy. U.S. exports have lagged since—and the U.S. trade deficit looks to have taken another leg up in the fourth quarter.

A primer on China reserve watching.

The Treasury's April foreign exchange report should be interesting. Thailand hasn't been included in past foreign exchange reports.  Yet it is likely to meet all three of the criteria set out in the Bennet Amendment for a finding of "manipulation." 

The ECB has almost certainly had a bigger impact on U.S. rates over the last three years than the PBOC, without buying (or selling) any Treasuries.

The Trump Administration wants to bring down the U.S. trade deficit. A number of manufacturing-heavy Asian economies run sizable current account surpluses. Over the course of the summer, some of them were clearly intervening to keep their currencies from rising against the dollar. But, somewhat surprisingly, this hasn’t caught the attention of the Trump Administration. The latest Treasury foreign exchange report removed Taiwan from the Treasury watch list even though Taiwan intervened over the summer to keep the New Taiwan Dollar from rising (at the 30 Taiwan dollars to the U.S. dollar mark). The report didn’t display any noticeable irritation at Korea’s continued propensity to buy dollars to keep the won from strengthening through the 1100 Korean won to the dollar mark. Korea bought foreign exchange in July, before the North Korean missile crisis intensified. The report continues to ignore Thailand, even though Thailand comes very close to meeting all three of the Treasury’s stated criteria for identifying manipulators (a bilateral surplus with the U.S. of over $20 billion, an overall current account surplus of more than 3 percent and intervention in excess of two percent of GDP). And Singapore got yet another free pass. These countries, not China, are at the epicenter of the recent return of foreign exchange intervention in Asia. India and Indonesia have also intervened, but they get off because they run current account deficits.* If you think countries with large current account surpluses shouldn’t be intervening in the foreign exchange market to help keep their currencies weak, there is plenty to complain about right now—more so than at any time since the dollar’s late 2014 appreciation. The combined current account surplus of these smaller Asian economies ($250 billion) is up substantially from 2007, and for that matter from 2012. And practically speaking, currency moves have a fairly predictable impact on the trade balance—convincing a number of Asian countries to let their currencies appreciate would likely have a more significant impact on the U.S. trade deficit than Trump’s high profile attempts to renegotiate existing trade agreements.  Centering the Treasury’s report around the three criteria set out in the Bennet amendment has strengthened the report’s analytical underpinning. At times in the past the report veered a bit too far from actual developments in the foreign exchange market—particularly in its description of the policies of individual countries. But I suspect that applying the three criteria too mechanically creates problems of its own—not the least because it is relatively easy for a country that is paying attention to engineer around the reserve accumulation criteria. At risk of intervening too much? Get your social security fund to buy a bunch of foreign assets in a new “diversification” push. Or have the finance ministry issue local currency bonds to set up a sovereign wealth fund that will buy foreign exchange from the central bank on an ongoing basis. Or let your forward book rollover directly to your sovereign wealth fund. Or ask your state banks to buy foreign exchange and provide them with an (undisclosed) hedge. I didn’t make any of the examples above up. The irony is that the more experience a country has with intervention, the easier it often is to hide the intervention. Concretely, I think the Treasury should make five adjustments to the foreign exchange report. (1) Assess more countries against the Bennet criteria. This one is easy. Expand the report to the top twenty trading partners. And automatically assess any country with its own currency and a current account surplus of over 3 percent of GDP. There is no good reason why the foreign exchange report right now doesn’t cover Thailand—which is less than $1 billion dollars away from meeting all three Bennet criteria (its bilateral surplus with the U.S. is $19 billion and change). (2) Deemphasize the bilateral balance. This one is a little tricky. The Trump administration has made the bilateral balance a key measure of trade success (it isn’t, especially in a world where bilateral trade is often heavily motivated by tax concerns. The focus right now is on goods trade, but the bilateral services data is even more problematic: the U.S. runs a healthy services surplus with Ireland and the “UK Caribbean”).** And well, the bilateral balance criteria is mandated by Congress: the Treasury cannot legally toss it aside entirely. But the bilateral balance currently has the effect of letting some countries that should get more scrutiny off the hook. Taiwan for example. Its bilateral surplus with the U.S. doesn’t breach the $20 billion threshold even though its overall current account surplus easily tops 10 percent of its GDP. Taiwan produces a ton of semiconductors (some based on licensed designs, with the royalties paid—I would guess—in no small part to the offshore subsidiaries of U.S. multinationals for tax purposes; some based on Taiwanese intellectual property) that are sold to Chinese firms that assemble electronics for reexport. Taiwan’s value-added bilateral surplus is far higher than its reported bilateral surplus with the U.S. The same is true of Korea. Korea now exports more semiconductors than autos. But the bilateral trade data shows only limited U.S. imports of Korean semiconductors (and for that matter, only modest imports of smart phones). Korean electronic components are often assembled elsewhere for re-export globally. And making a deficit in bilateral trade one of the currency report’s three criteria has let Singapore permanently escape the scrutiny its heavy intervention deserves, as Singapore runs a bilateral surplus with the U.S.*** Singapore is small, but its currency policy has long set a bad example for its neighbors.  (3) Stop giving countries a free pass on a large existing stock of reserves. Right now the Treasury deducts estimated interest income on a country’s existing stock of reserves from its estimate of intervention. That has the effect of giving a country like Taiwan—with reserves equal to 80 percent if its GDP—a pass on reserve growth of about one percent of GDP, if not a bit more. In my view, countries with high levels of reserves and large current account surpluses should be encouraged to sell the interest income for domestic currency and in turn use the domestic currency to pay the interest on their sterilization instruments or to remit profits back to the finance ministry. In Taiwan and Korea that would provide a revenue stream that could be used, for example, to pay for expanded social insurance. Counting interest income toward the two percent reserve growth threshold also is a way of recognizing that a large stock of reserves from past intervention has an impact on the current account (as Dean Baker emphasizes) not just intervention today. (4) Do not ignore the exchange rate at which a country intervenes. At 1100 won to the dollar, Korea generally runs a large current account surplus globally, and will export a ton of autos to the U.S. At 900 won to the dollar, Korea ran a much more modest surplus globally, and Korean auto makers have a strong economic incentive to produce in the U.S. rather than in Korea. The right level of the won to the dollar of course depends a bit on Korea’s own economic conditions and a bit on the dollar’s overall strength or weakness. But if the won is being kept too weak against the dollar, it is likely to be too weak against most currencies most of the time. The Treasury currently just looks at the quantity of intervention, not the timing of the intervention – and it doesn’t assess whether a country is stepping into the market at the right or the wrong level. The Treasury’s October report, for example, lauds Korea for reducing its intervention (the lower level of intervention is a function of large sales last fall when the dollar was appreciating strongly and Korea faced significant political uncertainty, Korea has resisted appreciation pressure by buying dollars at various points this year). But last I checked, Korea continues to have a policy of intervening to block appreciation when the won approaches 1100. And intervening at 1100 is a step backward in the grand scheme of things. In the years before the crisis, Korea waited for the won to appreciate to 900 before intervening (that was Korea’s policy in 2006 and 2007) and at times after the crisis it has waited for the won to approach 1000 before stepping in (admittedly, the won only reached 1000 once, in 2014; Korea usually stepped in at the 1050 mark). Looking at objective criteria like the amount of intervention was meant to take subjective judgments about the “right” level of the currency out of the report. I don’t think it works. Intervention at the wrong level should be called out even if it isn't big enough to cross the "sanctionable" threshold, particularly in a context where the government is actively encouraging a broad range of domestic investors to buy foreign currency. (5) Stop ignoring shadow intervention (e.g. the accumulation of foreign assets by actors other than the central bank).**** Here is a prediction: China, Korea, Taiwan, and Japan will never “show” reserve growth in excess of two percent of GDP when they meet the other two criteria for being named. It is too easy to shift foreign exchange off the central bank’s balance sheet and onto the balance sheet of other state actors. Korea for example has decided to invest a large share of the assets of its national social security fund abroad (the national social security fund is already huge, and—thanks to Korea’s high contributions and miserly social benefits—adding rapidly to its assets). Call it diversification if you want. It clearly has had the effect of structurally reducing Korea’s need to intervene in the foreign exchange market. Japan’s government pension fund has a huge pool of domestic assets that it could sell (to the central bank) in order to invest abroad if Japan had reason to be concerned about yen strength. China’s Belt and Road Initiative was originally designed, in part, to help the PBOC reduce its headline reserve growth—though it has subsequently taken on a life of its own. And Taiwan has encouraged outflows from its life insurers on a rather massive scale. I would be a bit surprised if they don’t have an explicit or implicit hedge with the government. The growth in their holdings of foreign debt mechanically has explained how Taiwan has been able to keep its intervention limited even with a massive surplus. Taiwan's financial institutions now hold almost as much foreign debt as Taiwan's central bank, and clearly have been doing most of the recent buying.**** In many ways this is the right time to try to establish a new global norm, one where countries with large current account surpluses don’t intervene to block appreciation—or encourage their state institutions to diversity into foreign assets—to help keep the currency weak. Korea, Singapore, Taiwan and Thailand all have current account surpluses of over five percent of their GDP; Singapore, Taiwan and Thailand have current account surpluses of over ten percent of their GDP (over the last four quarters of data). Setting out the norm when most countries are in violation of it is difficult, practically speaking. Better to spell out it out ahead of time and give countries a chance to adjust. That’s why the October report was a missed opportunity. The Treasury took the heat off just when several countries should have been put on notice for their intervention over the summer. * Switzerland has intervened heavily at times this year too, but the euro’s recent appreciation has taken a bit of pressure off the Swiss National Bank. ** The bilateral services trade is in its own way quite interesting. The U.S. runs a massive bilateral services surplus with Ireland, and an (admittedly small) deficit with Germany (a world renowned center of service excellence obviously!). The U.S. runs a massive surplus with the UK Caribbean (primarily in financial services) and to my surprise, a massive deficit with Bermuda (it is all due to reinsurance). It also runs a surplus with places like Switzerland and Singapore. That is why I suspect the bilateral services trade data is even more distorted by tax considerations than the bilateral goods data. (country numbers are from the U.S. services trade data, table 2.3) *** I would guess in part for tax reasons. Singapore is a hub for petrol refining, pharmaceutical manufacturing, and semiconductor manufacturing and testing. And well, the import and and re-export of Australian iron, which clearly is tax-driven. **** In some countries, like Japan, the finance ministry manages the bulk of the country’s formal reserves. But even in these cases there are ways of shifting foreign asset accumulation to less scrutinized institutions. ***** Since 2011, "private" holdings of portfolio debt—according to Taiwan's net international investment position data—have increased from 35 to about 80 percent of Taiwan's GDP. That's a lot of foreign exchange risk for domestic institutions to hold.

Analysis of the September intervention proxies for China and q2 Chinese balance of payments data.

For the past fifteen or more years, if not longer, the flow of foreign exchange in and out of China has never quite seemed to balance. Either the yuan was a one way bet up, and the PBOC had to buy foreign exchange to keep the currency from appreciating, or the yuan was (thought) to be a one way bet down, and the PBOC had to sell a lot of foreign currency to keep the yuan from depreciating. Neither was an especially comfortable position for the central bank. In August, though—and frankly through most of the summer—the available evidence suggests that inflows and outflows almost perfectly matched.* The stock of foreign exchange reserves reported on the PBOC’s yuan balance sheet—which shows its stock of foreign exchange reserves at its historical purchase price—didn’t move. And the numbers on foreign exchange settlement, which technically shows the flow of foreign exchange through the banking system but in practice tends to be dominated by the PBOC, show very modest net sales if you don’t adjust for reported forwards, and small net purchases if you do. It is pretty amazing if you think about it. The PBOC supposedly thought flows were close to balance when it reformed its foreign exchange regime way back in August of 2015, but quickly discovered that the apparent balance hinged on expectations that the PBOC would keep the exchange rate constant. Those expectations, obviously, were disrupted by the August 2015 depreciation. Two years and a trillion or so in reserves later,** and calm has been restored. To the chagrin of those who bet that the August 2015 depreciation augured a big future move down: some thought the depreciation signaled that China’s leaders wanted a much weaker currency (and I suspect China’s leaders did want a somewhat weaker currency; the yuan did depreciate against the CFETS basket from mid 2015 to mid-2016), others thought that the depreciation signaled that the PBOC was about to lose control over the exchange rate (not a view I shared). Yet it seems that the August equilibrium was itself somewhat fragile. The yuan shot up in the first week of September. I suspect—without having hard evidence—that the PBOC had to intervene to keep it from rising more. And then the PBOC loosened some of the controls that it had put in place to limit depreciation pressures. That was—rightly I think—interpreted as sign that China’s government didn’t want the currency to appreciate too much. The investment banks all seem to think that China’s exporters started to think the yuan was a one way bet up and started to unload the dollars they had accumulated back in 2016. Three more comments: 1) The PBOC could have used the reemergence of appreciation pressure to rebuild reserves, rather than to loosen controls. The fact that it didn’t suggests something about the PBOC’s policy goals. Among other things, it suggest the PBOC doesn’t think it needs more than $3 trillion in reserves. I agree. The three trillion number came from the heavy weight the IMF’s new reserve metric placed on local currency deposits if a country has a fixed exchange rate and an open capital account. The IMF’s China team, incidentally, also now recognizes—see paragraph 44 of its latest staff report—that the reserve metric doesn’t really fit China.*** 2) John Authers of the Financial Times noted last Friday that in China “the market and the economy are state-controlled.”**** That’s still largely the case for the onshore foreign exchange market, even if there are some channels that are difficult for China to completely control. China has lots of tools—especially now that it reversed the August 2015 reforms and effectively reintroduced the “fix” as a market signal back in June. It can dial capital controls up or down. And I think it can also dial the amount of state bank lending—and borrowing—from the rest of the world up and down. One reason why flows stabilized after the first quarter is that Chinese banks seem to have slowed their breakneck foreign loan growth (they also started borrowing more from the world, so their net foreign asset position stopped growing and actually looks to have shrunk a bit—but that’s a very technical topic for another time). In other words, balance in the market has come in part through managing the flows allowed to enter the foreign exchange market. I don’t really expect that to change—any coming liberalization is likely to be done in ways that are reversible.***** 3/ Exchange rate moves impact trade flows with a lag. The August appreciation of the yuan almost certainly had no impact on China’s August trade data (year-over-year volume growth was down a bit in August relative to July, but that is likely a result of standard volatility in the trade data—and the fact that the base from August 2016 was quite strong). A good rule of thumb is to look back a year to get a sense of the impulse the exchange rate is giving to current trade flows. And by that measure, China is still getting a boost from the exchange rate. Plus, well, the yuan—against the dollar—really isn’t that far from where it was eight or nine years ago and ongoing productivity gains should be leading the yuan to appreciate over time. And even with the yuan’s appreciation in August and September, the broad yuan is down close to 10 percent from its peak (against the CFETS basket)—though to be fair, that depreciation came after a significant appreciation in late 2014. I am not particularly impressed by the recent whinging of Chinese exporters (who probably should have hedged their future export orders earlier in the year but, well, probably didn’t when they expected the yuan to continue to depreciate). Chinese export growth in the first half of 2017 exceeded global trade growth, and exports to the U.S. have been doing just fine this year.     * There was a brief period in the summer and fall of 2012 when the PBOC doesn’t seem to have intervened much, as the euro crisis spilled over and triggered an emerging market sell-off. The foreign exchange reserves reported on the PBOC's balance sheet (in yuan terms) were also relatively flat for a period in late 2014 (when the dollar was appreciating), though the settlement data suggests sales in September and q4. ** About half of the fall in reserves is balanced by a fall in short-term debt. And a significant fraction of the remaining half a trillion is explained, in a mechanical sense, by the ongoing rise in the foreign assets of the state banks. *** I think it also doesn’t work that well for a lot of under-reserved emerging economies—largely because it gives equal weight to domestic and foreign currency deposits. **** “The market and economy are state-controlled (even if the profit motive is put to much more use than it was in previous communist experiments)”; I enjoyed the entire column, though I also tend to think that the eventual credit “reckoning” could still play out with some very Chinese characteristics (e.g. through a rather opaque recapitalization similar to what happened after 2003, though made more difficult by a slower underlying pace of growth). ***** I am not sure that is a bad thing by the way. I agree with Martin Wolf’s argument that it safer for everyone if China’s domestic financial system is kept one step removed from global markets so long as the domestic financial system has so many undercapitalized institutions (backed by an implicit or explicit state guarantee).

No sign of pressure on China's exchange rate regime in the June intervention proxies. Overall intervention in the second quarter is back at pre-August 2015 levels.

Some thoughts on how China's state banks may have funded their growing external loan portfolio

The proxies for Chinese intervention in May do not show any significant reserve drain

Chinese reserves appear to be stable over last three months.

Martin Wolf’s important column does a wonderful job of illustrating the basic risk China poses to the world: at some point China’s savers could lose confidence in China’s increasingly wild financial system. The resulting outflow of private funds would push China's exchange rate down, and rise to a big current account surplus—even if the vector moving China’s savings onto global markets wasn’t China’s state. History rhymes rather than repeating. And I agree with Martin Wolf’s argument that so long as China saves far too much to invest productively at home, it basically is always struggling with a trade-off between accepting high levels of credit and the resulting inefficiencies at home, or exporting its spare savings to the world. I never have thought that China naturally would rebalance away from both exports and investment. After 2008, it rebalanced away from exports—but toward investment. There always was a risk that could go in reverse too. In one small way, though, I am more optimistic than Martin Wolf. I suspect that China’s regime was under less outflow pressure in 2016 than implied by the (large) fall in reserves, and thus there is more scope for a combination of “credit and controls” (Wolf: "The Chinese authorities are in a trap: either halt credit growth, let investment shrink and generate a recession at home, a huge trade surplus (or both); or keep credit and investment growing, but tighten controls on capital outflows") to buy China a bit of time. Time it needs to use on reforms to bring down China’s high savings rate. All close observers of China know that China has been selling large quantities of reserves over the last 6 or so quarters. The balance of payments data shows a roughly $450 billion loss of reserves in 2016, with significant pressure in q1, q3, and q4. The annualized pace of reserve loss for those three quarters was over $600 billion (q2 was quite calm by contrast). But close examination of the balance of payments indicates that Chinese state actors and other heavily regulated institutions were building up assets abroad even as the PBOC was selling its reserves. In other words, a lot of foreign assets moved from one part of China’s state to another, without ever leaving the state sector. For a some time I have tracked the balance of payments categories dominated by China’s state—and, not coincidentally, categories that experienced rapid growth back in the days when China was trying to hide the true scale of its intervention. One category maps to the foreign assets the state banks hold as part of their regulatory reserve requirement on their deposit base. Another captures the build up of portfolio assets (foreign stocks and bonds) abroad, as most Chinese purchases of foreign debt and equity historically has stemmed from state institutions (the state banks, the CIC, the national pension fund). Even if that isn't totally true now, portfolio outflow continues to take place through pipes the government controls and regulates. These “shadow reserves” rose by over $170 billion in 2016, according to the balance of payments data. The state banks rebuild their foreign currency reserves after depleting them in 2015, and there were large Chinese purchases of both foreign equities and foreign debt. And the overseas loans of Chinese state banks—an outflow that I suspect China could control if it wanted to—rose by $110 billion. As a result much of the foreign exchange that the central bank sold ended up in the hands of other state actors. My broadest measure of true official outflows* shows only $150 billion in net official sales of foreign assets in 2016. Not a small sum to be sure. But not an unmanageable sum. That kind of outflow can easily be financed out of China’s large foreign exchange reserves for a time, or China could more or less bring the financial account into balance by limiting the buildup of foreign assets by the state banks and simultaneously cracking down on outward FDI (over $200 billion in outflows 2016, and largely from state and state-connected companies). In other words, much of the reserve draw was offset by the buildup of other state assets—especially counting the assets state banks and state firms acquired abroad.** That I suspect is why flows suddenly started to balance once China tightened its controls (and likely made it harder for one part of the state to bet against another part of the state). Of course, the renminbi’s relative stability against the dollar also helped—you do earn more on a bank deposit in renminbi than on a bank deposit in dollars. There are of course still private outflows. But the outflows aren’t that much bigger than what China could finance out of its export surplus. If you take the growth in the state banks' overseas assets ("other, other assets" and "other, loans, assets" for the BoP geeks) out of the data, it seems that the pace of outflows actually slowed a bit in 2016. Of course, I do not like simple stories. I think the outflow numbers on the financial account are a bit less scary after you adjust for the financial activity of China's state, but I also think the current account may disguise some real private outflows. Bottom line: the 2016 reserve drain was offset in part by the buildup of assets at the state banks and in other large regulated financial institutions, so it is a bit less scary than it seems—for now. Especially in a context where China’s growth is accelerating, China is on a tightening cycle and, for now, the dollar isn't appreciating in the way many expected. * This measure includes the foreign loans of China's banks (assuming, correctly, that all the major lenders are state-owned), the traces the PBOC's other foreign assets leave in the balance of payments data (other, other, asset -- which reflects the foreign assets the banks hold as part of their regulatory reserve requirement on domestic deposits) and portfolio equity and debt. Historically, the CIC has dominated portfolio equity outflows and the state banks accounted for most portfolio debt outflows. That is a bit less true now, so this arguably over-counts. If that is the case, I would welcome a revision to the Chinese balance-of-payments data that splits out China's holdings of portfolio assets abroad by sector -- consistent with the reporting provided by many other countries. One thing though is clear: portfolio outflows are governed by quotas and are executed through channels the state regulates. They cannot happen without state approval. ** This would explain in part why the data on fx settlement, which includes the state banks as well as the PBOC, shows fewer sales than implied by the change in the PBOC's foreign balance sheet.

The proxies for Chinese reserve sales show very modest sales in February. Foreign exchange settlement (which includes the state banks) shows $10 billion in sales, and only $2 billion counting forwards. The PBOC’s balance sheet shows similar changes—foreign reserves fell by $8.5 billion and foreign assets fell by $10.6 billion. No wonder the (fx) market is no longer focused on China. The fall off in foreign exchange sales is particularly impressive given that China didn’t have its usual trade surplus in February, for seasonal reasons (China’s trade often swings into deficit during the lunar new year). Modest reserve sales alongside a monthly trade deficit imply that the pace of capital outflows fell. The only analytical problem is that the fall in pressure on the renminbi is a bit over-determined. Controls on outflows were tightened. For real, it seems. That likely helped. And the yuan was stable against the dollar, broadly speaking. There continues to be a correlation between movements in the yuan and the pace of outflows. In other words, to stabilize outflows, it really helps if China at least keeps the yuan stable against the dollar. Any depreciation (against the dollar) tends to generate expectations of more depreciation. Chinese firms with dollars want to hold on to them. And so on. Appreciation against the dollar by contrast tends to encourage firms with dollars to sell their dollars and bring their money home. The interest rate on the yuan is higher than on the dollar remember; holding dollars can be costly. The data for March won’t be out for several more weeks. Given the dollar sold off a bit in March, allowing the yuan to rise a bit against the dollar within the broad context of managing against a basket—there is no strong reason though to think pressure on the yuan has returned. One implication: the money market tightening in China likely was done for domestic reasons, not as a by-product of an effort to support the currency. I though do wish that China had been a bit symmetrical in its management against the basket, and had not (once again) used the dollar’s weakness as an opportunity to let the yuan slide (a bit) against the CFETS basket (see the chart above). China needs to add to the two way risk around the yuan. That will not happen if the big players in China’s foreign exchange market think the yuan will be stable against the dollar when the dollar is going down, and will depreciate against the dollar when the dollar is going up (and thus grind down against the basket). So in my view, China either missed an opportunity to let the yuan rise a bit more against the dollar and add to two-way risk, or signaled that it has reverted to managing the yuan against the dollar once again.