Thursday, April 12, 2007
Yesterday, Macro Man wrote that he had a bigger beef with China’s FX reserve policies than he did with the level of the RMB per se. Now, the two issues are intimately related, of course, as a change in the prosecution of the former would indubitably result in a change in the value of the latter. Nevertheless, it is the distortions caused by reserve growth that pose the larger structural threat, in Macro Man’s view, because of the artificial compression of risk premia that result.
Well, China released Q1 FX reserve data last night...and it really makes Macro Man wonder what the hell they are playing at. The stock of reserves increased by a whopping $136 billion in the first quarter alone, a growth rate that is looking decidedly parabolic.
What makes the reserve growth particularly galling is that the have authorities dramatically slowed the pace of RMB appreciation since mid February. Now, maybe this has been in preparation for a large one-off step revaluation of the RMB....but probably not. And obviously, ex-post, it’s difficult to reconcile RMB stagnation with any myths about capital xportation when Q1 reserve growth exceeded the reported trade balance by almost $90 billion. The only reasonable explanation is that Q1 saw a deliberate attempt to slow the pace of RMB appreciation and/or accrue FX reserves. And while Macro Man is certainly no fan of protectionism, he does think that China (and indeed Russia) needs to be called onto the carpet. Perhaps the G7/IMF will do so this weekend. Failing that, maybe the US Treasury report on currencies will finally name and shame China for taking the piss.
In any event, the upshot is that China, Russia, India, and the rest of their brethren have a lot of wood to chop in terms of their reserve management. Macro Man estimates that those three plus Taiwan, just by themselves, needed to buy €35 billion in Q1 just to maintain portfolio benchmarks. While these guys have certainly been active so far this year, Macro Man does not have the sense that they have shifted this sort of size- otherwise, the euro would be even stronger. And the higher the euro goes, the larger the performance lag against benchmark will- and thus the greater the pressure to come to market. It is for this reason that Macro Man fears that USD/Europe could be perched on the edge of a precipice, near term.