The Federal Reserve has signaled that it plans to taper the $120-billion-a-month quantitative easing (QE) program by year end. The full details are expected to be discussed when the next Federal Open Market Committee (FOMC) policy meeting convenes later this month. Although conditions might change by then, the prevailing wisdom on Wall Street suggests that the Eccles Building will move ahead with curtailing the monthly asset purchases. However, there is one party that is ostensibly unhappy about the decision: China. Will the U.S. central bank poke the Red Dragon by flooding the financial markets with less freshly printed cash? If so, how will Beijing respond?
China’s Capital Exodus
Chinese financial regulators are on red alert over what they call “malicious” capital outflows from the world’s second-largest economy. Fang Xinghai, deputy chairman of the China Securities Regulatory Commission (CSRC), warned of an exodus of funds retreating to the United States as the Fed scales back its monetary policy, a move that could lift the greenback. As a result, Fang recommends greater monitoring of cross-border hot money movements that might threaten the stability of capital markets.
“It is normal for some foreign investors to relocate their assets considering the changes to international monetary policies. This won’t lead to big inflows or outflows,” Fang said during the China International Finance Annual Forum. “However, we must prevent some foreign-funded institutions from facilitating market changes with their investment decisions. This is where we must pay particular attention.”
He called these efforts “malicious actions” that “will be stopped” immediately upon discovery. However, it remains unclear as to what is defined as malicious. That said, Zhou Liang, deputy chairman of the China Banking and Insurance Regulatory Commission, shared the same concerns, sounding alarm bells over “severe after-effects” in Beijing.
Since President Xi Jinping opened the nation’s financial markets to the rest of the world, foreign investors have invested $537 billion into Chinese A shares, representing approximately 5% of market capitalization. This was supported by greater liberalization of China’s markets and the rapid expansion of the money supply that slashed interest rates and sent investors to push their cash in other markets. Now that QE is potentially winding down, the money is coming back home.
Should the situation escalate, how will Chinese authorities, either in the central government or the People’s Bank of China (PBoC), respond?
Fire Breathing on the Fed?
At home, financial authorities are so worried about the capital exodus that regulators are performing a series of measures to absorb the shock. For example, the PBoC performed several stress tests for its financial stability report, allowing the institution to determine how banks handle macroeconomic shocks, repayment capability, cross-market risk factors, and liquidity.
The country’s largest banks, which own more than three-quarters of the economy’s total loan value, were strong to fight macroeconomic, credit, and market challenges. However, the nearly 4,000 small- and medium-sized businesses (SMBs) could crumble under the pressure of debt, particularly if the non-performing loan ratio significantly increases.
For now, PBoC representatives are satisfied by what they see. But the central bank will continue to install preventative solutions to dissipate the myriad of financial risks and, according to the institution, “pay close attention to preventing shocks from external risks.”
Could Beijing retaliate when it comes to the dollar? The latest numbers from the U.S. government show a gradual decline in China’s holdings of Treasury securities over the last year, falling about 2% to $1.061 trillion. For four consecutive months, China has trimmed its holdings of American debt. Indeed, if President Xi and his merry band of communists were fearful of a strengthening dollar, all he would have to do is flood the markets with the dollars in China’s possession.
This had been one of the chief concerns before the coronavirus pandemic during the contentious trade dispute. But nothing came of the threat since China understood that it would crash the global financial markets and endure as much pain as the advanced economies and developing world.
Will Fed Taper the Taper Talk?
A lot has transpired since the annual Jackson Hole event, mostly adverse. The August jobs report was disappointing, falling short of market forecasts. The trio of August purchasing managers’ index (PMI) figures, which emphasize the general direction of economic sectors, extended their declines. The number of coronavirus cases, including among the vaccinated, is rising across the country. Finally, Jerome Powell and associates might get cold feet ahead of the FOMC powwow and refrain from taking the Fed’s foot off the pedal. If so, this would potentially relieve Beijing and U.S. markets since both have become dependent on easy money emanating from the printing press inside the basement of the Federal Reserve System.
Read more from Andrew Moran.