China, Brazil and Nightmare Swaps

Discussion in 'Economics' started by Stockolio, Aug 6, 2019.

  1. Beyond just the daily band, to peg CNY around the midpoint and to keep that midpoint nearly the same every day requires constant vigilance and direct activity. You might amass a war chest of off-balance sheet funds using “contingent liabilities” staggered out at three-month intervals.

    In other words, you borrow a ton of US$’s upfront in FX swaps and the like, keeping them off the books (kind of). The first batch of those swaps will be coming due three months from now. The second in six months. And so on.

    You use these “contingent liabilities” you’ve gathered ahead of time as fuel, doling it out in piecemeal fashion to fight the daily war to keep CNY close to its midpoint. If you can keep it near the midpoint that also means you can keep the midpoint from moving much day to day. The steadier the exchange value, maybe to the point of it looking like it is pegged, the costlier the output.

    If you are being bold, like the PBOC, say, in November 2018, you could even try to engineer a higher CNY – but that’s going to mean using up a lot of ammunition.

    The goal is relatively simple: convince the market that nothing is wrong, or at least if there is something wrong it’s not something you can’t handle (and the media will help you out by claiming all these things). The currency appears to be stable, and that will let time heal every wound. Three months from now when the first batches of FX swaps begin expiring, you hope and expect that whatever was bugging the eurodollar markets no longer is.

    If on the other hand the eurodollar system is unconvinced by an artificially stable CNY, you’ve just made it worse (the nightmare).

    To oversimplify again, let’s assume [local banks] need to borrow $100 every day in short-term eurodollar markets just to keep doing the vital economic and financial things [banks] do. One day, the eurodollar market demands $110 for whatever reasons including problems on its own end. As the central bank, [you] promise to help [them] by giving [them] the extra $10 because [them] not having that $10 means [they] don’t get all of the $100 and therefore all sorts of bad things for you as well as the economy.

    [You] can sell $10 in assets [you] already own, which, as noted above, means that’s $10 subtracted from the domestic monetary base. Or, the Brazil option, [you] can give [banks] $10 today by promising to obtain $11 three months in the future. It sounds absurd, but that’s really what happens and it keeps the $10 in place for the domestic base while simultaneously giving [banks] an acceptable liability covering [their] $10 shortfall.

    Three months later, [they] are still borrowing the $100 on eurodollar markets as [they] always do, but now [you] have to borrow $11 on top of it, to close out that prior intervention. If the eurodollar market has gone back to normal, great. If the eurodollar market still demands $110 from [them], then [you] have double the problem.
  2. So, you now have these three-month intervals where you have to decide to increase the subsidy you are giving your local banks (the “contingent liabilities” are the basis for you to provide the subsidy of forward cover, the daily ammunition to keep CNY and the midpoint stable) or you have to back off because if you keep doing it the costs will pile up very quickly (and will mean huge RMB contraction in the future).

    The market price tends to get lower (Chinese banks being asked to pay up for perceived risks) and because you no longer wish to intervene and subsidize you have to set tomorrow’s midpoint to take account of these negative pressures. And then the day after that, and so on. Before you know it, CNY DOWN. Not just down, but CNY DOWN every three months as those batches of “contingent liabilities” keep coming due.

    Either you pony up more of them, to add more to your off-balance sheet war chest at the expense of future RMB, or you let them, and CNY, go.

    That’s not the only problem in all this mess, either. If you are allowing FX to expire that doesn’t just mean the swaps disappear. You’ve borrowed contingent funding from the derivatives market and if you aren’t going to roll them over every three months you have to borrow some dollars (or sell UST’s) to settle out – which adds a little (maybe a lot) more onto demand for dollar funding.

    Just like 2015, as CNY plummets seemingly out of control the mainstream still unaware of how anything fundamentally works will try to explain all this as competitive devaluation. This time, we are being told, it is President Trump’s fault for trade wars. The Chinese are just manipulating their currency in response to that.

    China is manipulating its currency, alright, but as a passenger on the eurodollar train. The fact that it keeps to a regular schedule doesn’t suggest control; quite the opposite.
  3. Overnight


    What I know is, is that everyone had been doing just fine until Trump started the trade was last year. And with each escalation, the threat to global growth has increased. WHO THE HELL CARES WHAT IS DOES TO OUR TRADE DEFICIT? Everything was going along great! This shit is going to bite us in the ass so hard it will make 2008 seem like a flesh wound.

    ONE MAN. There was NO need for this. All you protectionists out there can lick my taint. I hope you enjoy your next needless recession, and I hope it wipes out all your bankrolls, you dumbasses.