This Could Ignite a Chinese Economic Collapse in 2016

China Economic CollapseIs China on the Verge of Economic Collapse?

Some fear that the suspension of currency trading rights for some international banks represent a major effort to stop the current wave of capital outflows, heralding a potential Chinese economic collapse in 2016.

China’s central bank (the People’s Bank of China, or PBOC) has a problem in keeping the yuan under control. Now the country’s government has ruled out three foreign banks from foreign exchange transactions until the end of March, according to Reuters, which cites sources who have witnessed the notices of suspension. (Source: “China suspends forex business for some foreign banks,” Reuters, December 30, 2015.)

A ban on banks operating on the offshore markets raises questions about the very status of the free market of China. Indeed, the measure appears to be at odds with the government of China’s ambitions to internationalize the currency, especially after the International Monetary Fund (IMF) included it as part of its “special drawing reserves” (SDR) at the beginning of December. The SDR recognition was not just important for the yuan; it was an important recognition of China’s status as an advanced economic power.

As for the suspended services, they include, among others, the ability to liquidate clients’ positions and other cross-border, onshore, and offshore transactions. The sources reported that the PBOC has not explained its motivations behind suspension. They speculate that the authorities have targeted the banks because of the significant size of their cross-border forex operations and fears of a Chinese economic collapse in 2016.

One of the banks suspected of being affected by the ban is Deutsche Bank, according to a recent survey by Asiamoney, which pointed to Deutsche Bank as the main forex activity “culprit” in China, as well as HSBC, Citigroup, and BNP Paribas. (Source: “China said to suspend forex business for some foreign banks,” LiveMint, December 30, 2015.) There was no comment from the bank in London.

A Chinese economist suggested the measure is intended to stop growing demand for U.S. dollars in response to the widening gap between the onshore and offshore yuan exchange rates: “They hope to ease foreign exchange buying pressure and ease depreciation pressure on the Yuan… But I don’t think the authorities will take very strong capital control measures, they are likely to reinforce the existing measures.” (Source: “China suspends forex business for some foreign banks,” Reuters, December 30, 2015.)

Indeed, China has taken a series of measures to stabilize the yuan since its surprise devaluation of August 11. The significant capital outflows reflect rising fears of a Chinese economic collapse, notwithstanding the fact it is the world’s second-largest economy.

Over the past three months, PBOC had ordered banks to monitor the forex transactions of their clients to prevent illegal cross-border trade-offs between the yuan in the domestic and foreign market. The difference (“spread”) between the two courts has increased since last summer’s devaluation, which predictably made it more difficult for the PBOC to manage its currency and prevent outflows.

The yuan “onshore” CNH = CFXS traded in Shanghai lost 1.44% of its value since the end of November, falling to the lowest level of the past four-and-a-half years. Meanwhile, the yuan “offshore,” traded in Hong Kong, saw a similar pattern. On December 30, it touched its lowest level since September 2011—6.60 per dollar. (Source: Ibid.)

The yuan depreciation and the government’s contradictory efforts to interfere in the free market have prompted the United States to question the very nature of China’s “market economy.” As noted in the Financial Times, Washington is objecting to China being granted the official status of “market economy.” (Source: “US warns Europe over granting market economy status to China,” The Financial Times, December 28, 2015.) The EU, according to the U.S., is committing a serious mistake by granting Beijing (by the end of February), the “market economy” status because it would undermine the very rules of the market itself!

The United States is concerned by the possibility of “dumping” by China. Beijing, without duties, would end up flooding the European market with products produced thanks to state subsidies and a lack of rules in the labor market.

Washington fears this could cause a major crisis in the European economy, especially in the manufacturing sector. Nevertheless, Beijing, for its part, is confident of its position as part of the 2001 agreements that allowed it to join the World Trade Organization (WTO) in the expectation of being given “market economy” status.

To convince Europeans, Beijing has invested greatly in assets and industries in crisis, increasing wages and demanding its companies abide by its commitments. While the U.S. is no stranger to the matter of subsidies, Europe is determined to proceed, with the U.K. and Germany in the lead, in order to please Beijing. This, together with the yuan ending up in the basket of reserves of the IMF, is one of China’s most important diplomatic results of 2015.

Finally, in 2016, rising political tensions in eastern Asia may affect the economic and financial mood in the region as well, raising the chances of a market crash in China or even of a Chinese economic collapse. Beijing’s efforts to assert its sovereignty over most of the South China Sea and the rise in construction activity surrounding structures that resemble military installations are inflaming fears and concerns among other countries claiming competing interests in such areas as the South China Sea or the East China Sea. (Source: “New China airstrips a potential headache for neighbors, US,” Jakarta Post, December 6, 2015.)

In order to challenge Chinese power, countries such as the Philippines or Indonesia continue to favor a U.S.-led Asia and could increasingly welcome the rise of a stronger military in Japan. The elections in Taiwan in 2016, which are expected to see a victory of the independence-minded DPP party, will surely contribute to the rise in tensions, causing missteps in Beijing. This would have negative repercussions in the Chinese stock market, including a potential Chinese economic collapse in 2016.