The author is an independent investment strategist and the founder of the online research market ERIC
For the first time, foreigners have large enough positions in RMB-denominated securities to influence China’s monetary policy.
China’s foreign investment has always been dominated by direct investment, and investment in portfolio assets is mainly limited to foreign currency debt.
The situation has changed dramatically in the past 10 years. In 2011, the size of China’s current portfolio assets held by foreigners was only 14% of the size of China’s reserve assets. In June, their size was almost two-thirds of the $2.1 trillion.
This surge, combined with the country’s managed exchange rate policy, gives foreigners a new power, which is demonstrated when considering the relationship between the size of China’s investment portfolio assets held by foreign countries and the size of the country’s foreign exchange reserves. .
In 2011, the US$458 billion of Chinese liquid investment portfolio assets held by foreigners accounted for 14% of China’s reserve assets. Today, the percentage is about 5%, but in absolute terms, the holdings are much higher, at $2.1 trillion. What happens if these assets are liquidated?
The downward pressure on the RMB exchange rate forced the People’s Bank of China to intervene. With the reduction of foreign exchange reserve assets, liabilities in the form of bank reserves denominated in RMB have also decreased. The actions of foreign investors will require tightening of monetary policy through this process, just as China is struggling to cope with falling residential real estate prices and increasingly serious difficulties in the private credit system.
The consensus of professional investors is that foreign holdings of Chinese investment portfolio assets can only continue to increase. The reason is that Chinese bonds can provide irrelevant returns, thereby increasing their value to any diversified investment portfolio, and they are in great demand.
This confidence in future portfolio asset inflows is supported by the belief that those who construct global portfolio asset benchmark indexes and those who blindly capitalize will only increase the weight of Chinese portfolio assets in these indexes.
However, there are more and more reasons why foreign investment portfolio flows into China will stop or even reverse. The increased risk of the Cold War means that it is unclear whether foreigners are allowed to purchase Chinese government bonds to fund the Chinese government’s military construction, or even part of the capital.
Increasing attention to environmental, social and governance issues may affect the ability of foreign investors to increase their position in China. China’s growing internal problems have exacerbated these key external factors.
The overbuilding of China’s residential real estate market is nothing new, but its prices have recently fallen due to signs of a credit crisis among developers.
This dilemma is compounded by China’s President Xi Jinping’s attempt to draw a line between public risks that can be financed by the state-controlled banking system and private risks that should not be obtained from that source. Investors who believe that companies that obtain loans from state-owned banks are a public risk are repricing these risks.
All of this is especially bad news for the informal credit system, because it often no longer allows state-controlled banks to provide funds.
The managed exchange rate operation has kept China’s monetary policy tight, and broad money growth has approached its post-war low. Although foreign investors investing in Chinese government bonds may welcome tightening of monetary policy, they are more likely to scare foreign capital out of the Chinese stock market.
Xi Jinping’s goal of creating greater “common prosperity” in China will not necessarily reduce private property rights, but it is likely to reduce.
The history of money is the history of how politicians need to control the price and quantity of money in order to achieve their political goals. Xi Jinping’s current common prosperity goal is constrained by the tightening of monetary policy caused by China’s managed exchange rate operation.
Sometimes, political leaders must choose between adjusting for deflation or turning to exchange rate flexibility to control the price and quantity of currencies and eliminate debt through inflation.
China’s debt-to-GDP ratio has soared since 2009 and is now as over-leveraged as developed countries.
Xi Jinping’s political goals are no longer compatible with a stable Chinese exchange rate. Xi Jinping must choose between flexible exchange rates and currency independence or deflationary economic adjustments accompanied by financial and political risks.