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[Thai at Heart]

Rule changes for commercial banks are acting as cover for exchange rate intervention, writes Ambrose Evans-Pritchard - Source Daily Telegraph UK

China has resorted to stealth intervention in the currency markets to amass US dollars, using indirect means to hold down the yuan and ease the pain for its struggling exporters as the global slowdown engulfs the economy.

A study by HSBC's currency team in Asia has concluded that China's central bank is in effect forcing commercial banks to build up large dollar reserves, using them as arms-length proxies in a renewed campaign of exchange rate intervention.

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Beijing has raised the reserve requirement for banks five times since March, quickening the pace with two half-point rises in late June.

This is having major spill-over effects into the currency markets because banks in China have been required over the last year to hold extra reserves in dollars rather than yuan. The latest moves have lifted the mandatory deposit from 15pc to 17.5pc of total lending since March.

"China has used the pretext of reserve requirement hikes to help slow yuan appreciation. We estimate that the PBOC [central bank] intervened by about $49.6bn in June," said Daniel Hui, the bank's Asia strategist.

Beijing has also slashed the amount of foreign debt banks operating in China can hold. The effect is to oblige the banks to become net buyers of dollars, halting the flow of foreign "hot money".

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Given the sheer scale of China's foreign reserves - now $1,800bn (£970bn) - any shift in its exchange policy now ripples around the globe. The covert buying may help to explain at least part of the explosive dollar rebound over recent weeks.

There is little doubt that the key driver behind the wild currency ructions this summer has been the blizzard of dire data from Britain, Europe, Japan and Australasia. The mounting danger of a full-fledged recession across the club of rich OECD nations appears to have caught the markets off guard.

The closely watched Dollar Index reached an all-time low in March. It crept up gradually in the early summer before smashing through resistance in July.

The world's currency system is swivelling on its axis. Central banks in Asia and Europe have stopped raising rates, and some have begun to cut aggressively. The Federal Reserve is no longer nakedly exposed. Indeed, investors are already starting to look ahead to the next round of Fed tightening.

The 18pc slide in oil prices from a peak of $147 a barrel in July has added juice to the dollar rally. Russia and the Middle East petro-powers tend to recycle a high proportion of their vast earnings from oil into the eurozone, either by purchasing European bonds or expensive imports.

A Bundesbank study found 40 cents of every dollar spent by eurozone countries on oil imports comes back again one way or another. The figure for the US is just 10 cents. This trade bias has given oil a new character as a sort of anti-dollar driving the currency markets.

Even so, the China effect is a key ingredient in the dollar comeback. Beijing's Politburo is clearly disturbed by the sudden downward turn in the economy as export markets freeze, and surging wage inflation in the country's manufacturing hubs eats away at profit margins.

"They are now more worried about growth than overheating, and you are seeing that play out in the currency markets. There has been a remarkable change of view," said Simon Derrick, exchange rate chief at the Bank of New York Mellon.

China's PMI purchasing managers index fell below 50 for the first time in July, signalling an outright contraction in manufacturing output. Hong Kong's economy contracted 1.4pc in the second quarter. The Politburo has rushed through special rebates for textile producers now caught in a ferocious downturn.

Much of the clothing, footwear and furniture industry has been hit, leading to mass plant closures in the Pearl River Delta.

"During the first half of this year, about 67,000 small and medium-sized companies went bankrupt throughout China, leaving more than 20m people out of work," said the National Development and Reform Commission. "Bankruptcies of textile and spinning companies have numbered more than 10,000. Two thirds are on the brink of bankruptcy."

Last week's rebound on the Shanghai stock market stalled on fading hopes of a fiscal stimulus package. "It is unrealistic to expect the government to rescue the market," said Li Ka-shing, chairman of Hutchison. "Speculators should be very cautious now. The worst is not over in the global credit crisis."

Lehman Brothers warns of a risk that a housing slump and the 55pc equity crash since October could combine with a global downturn to set off a "vicious cycle". House prices have already fallen 18pc in Guangzhou and 9pc in Beijing. Prices are now falling in cities that make up over half China's population.

Have your say

[lannarebirth]

Why is it important to know why?

[Samuian]

Beijing's Politburo is clearly disturbed by the sudden downward turn in the economy as export markets freeze, and surging wage inflation in the country's manufacturing hubs eats away at profit margins.

"They are now more worried about growth than overheating, and you are seeing that play out in the currency markets. There has been a remarkable change of view," said Simon Derrick, exchange rate chief at the Bank of New York Mellon.

China's PMI purchasing managers index fell below 50 for the first time in July, signalling an outright contraction in manufacturing output. Hong Kong's economy contracted 1.4pc in the second quarter. The Politburo has rushed through special rebates for textile producers now caught in a ferocious downturn.

Much of the clothing, footwear and furniture industry has been hit, leading to mass plant closures in the Pearl River Delta.

Has been anticipated for quite some time - remember this has happened to Thailand's clothing industry - expanding - contracting - expanding - contracting - shifts, cycles...bullish, bearish....there was a time when the dollar bought 0.84 Cent Euro sometime in 2001! (correct me if I am wrong!) Imagine the profit if One would have bought then and is selling now.....

Isn't it all about buying and selling... the housing/real estate market was on fire for quite some time, some secured the profit, some are licking their wounds!

Edited August 26, 2008 by Samuian

[LaoPo]

...One of the many many reports and studies by one of the world wide banks, this time the currency team of the HSBC. They do a lot of studies these days.

But, Li-Ka Shing is right when he says "The worst is not over in the global credit crisis."

It isn't indeed.

But, China banks are reporting HUGE RECORDS of profits these past few days whilst Western Banks are in deep trouble.

And, as far as China's situation is concerned: they're trying to steer a giant ship with 1,3 Billion people as good as possible, like any other country or Central Bank in the rest of the world would try to do (Thailand is a nice example ) and as demand slides in the west, production declines in China.

For investors with cash there are lots of opportunities around the corner.

It's like a rocking chair...economy.

LaoPo

[Thai at Heart]

Why is it important to know why?

Ummm, since this is a business discussion forum, knowing that the Chinese Central Bank is requiring domestic banks to buy dollars might be of useful knowledge, since with the US on the verge of meltdown an appreciating USD might effect someone day by day.

[VegasVic]

Why is it important to know why?

Ummm, since this is a business discussion forum, knowing that the Chinese Central Bank is requiring domestic banks to buy dollars might be of useful knowledge, since with the US on the verge of meltdown an appreciating USD might effect someone day by day.

Thai at Heart, where have you been for the past year, in a coma? The U.S. has already had their real estate and financial crisis and is on the way back up, if you are looking for something on the verge of a meltdown then gaze upon the very real and serious troubles in G.B. currently also in many of the EU member nations, or the Russian stock market or the continuing meltdown of the Shanghai stock exchange (sorry if that one came a little close to home). As for the Dollar, it is not really strengthening (yet) it has just merely been artificially depreciated for a few years now and is making a upward corrective move. In 2009 you will see the Dollar enter a true strenghtening mode as the FED begins to increase rates, the EU central bankers are forced to lower rates, and oil continues its downward move. BTW in regards to your OP, China acts in its own best interest and they can see the devestation that is about to occur in G.B. and the EU, and the Dollar and Dollar denominated investments are looking awfully good right about now