Three Influential Factors in Global Financial Trends Today
The shrinking of the Fed's balance sheet that causes the anxiety among many analysts may not be a simple mechanical linear process, but the appropriate decision-making measures, more or less, on the reaction from non-US economies. In contrast, if Trump was impeached during his political chaos or his power is greatly restrained, it is hard for his tax-cutting and other policies to be carried out, thus affecting the real economy and stock market which is at a historic high. This factor may form a hedge with US capital inflow which is brought by the shrinking of the Fed's balance sheet.
China's financial market-oriented on reduction of liquidity is expected to be relatively cautious, low-key and pragmatic, so that China's financial markets can be stable in this round of international financial fluctuations, and can also enhance the depth and quality of China's financial markets, which finally can lay the practical foundation for the international monetization of RMB and the full liberalization for the trading of Chinese financial products.
In the most recent period, with the finalization of the Dutch and French elections, the international political and economic circles have been slightly relieved. The worrying results do not happen, and Europe seems to return to the general line of political and economic integration. However, the shrinking of the Fed's balance sheet then results in new worries and fears.
As for the so-called shrinking of the Fed's balance sheet, the Fed Chairman Yellen, Vice Chairman Fischer, and other members of the Federal Open Market Committee (FOMC) recently make it clear that the Fed will launch the quantitative and loose reverse operation in the near future, that is to sell their US treasury bonds and other financial assets up to 3.6 trillion US dollars in some way and at some rhythm which had been bought over the past five or six years.
The financial markets generally believe that the shrinking of the Fed's balance sheet, due to its potential to sell US treasury bonds up to 20% of the current US treasury bonds, will definitely drive the rise in US treasury yields, and enable the US fixed income assets to be more attractive globally, triggering global capital flows into the United States and filling the gaps in liquidity. Many people further believe that this will lead to a boom of emerging market funds back to the United States, which will bring the risk of an asset bubble burst in some emerging market countries. Some people even believe that this will trigger a round of looting shearing action by foreign investors due to the sharp decline in the price of financial assets of emerging market countries. This analysis is not unreasonable, but seems too simple.
As for the impact factors of today's international financial market trends, in addition to the Fed, we also must see the political chaos in the United States over more than three months since the inauguration of Trump, which we may call as Trump's political chaos, as well as a low-key financial market adjustment which is in the process carried out by the central bank and the financial authorities of China. These three factors together can affect the global financial market trends. After all, the Fed only controls the US interest rate and liquidity easing, while Trump's political chaos is affecting the US real economy trends and investors' confidence, which directly affects the US stock market trends. In addition, China has been developed into the world's second-largest economy, playing an important role in the world with regards to the scale of financial markets, including the scale of bank loans and various financial products sold by commercial banks. These three factors together can affect the overall trend of international financial markets, which must be fully considered.
Shrinking of the Fed's balance sheet is most likely to act with caution
According to the recent opinions of the Fed's management, the original intention of the shrinking of the Fed's balance sheet is very simple. Their basic concern is that the US domestic liquidity is too loose, resulting in price increases. They believe that the US inflation rate is close to the upper limit of 2%, while the wage increases are accelerating, the unemployment rate has reached the lowest level in recent decades, and the labor force has been fully employed. Therefore, it is necessary to find ways to start the shrinking of US domestic liquidity. Of course, the Fed does not take full account of the impact of the shrinking of the Fed's balance sheet on other economies around the world.
However, the analysts have forgotten that, after the financial crisis, the Fed has been fully aware of its actions, from the rate hike to the shrinking of the Fed's balance sheet, must fully consider the impact on the US financial market, and also take partial account of the impact of foreign real economy and financial markets.
At the end of August 2015, the author attended the annual meeting of the Fed in Jackson Hole and was invited to give a luncheon speech. After then, the Fed officials made it clear that the rate hike had to take into account the factors such as China's financial markets and exchange rate fluctuations.
As expected, after the annual meeting, the United States postponed the rate hike. They actually took the Chinese real economy and financial market fluctuation in part as a consideration factor in the development of monetary policy. And yet for all that, the intensity of this consideration should also be greater from the perspective of China.
On this logical basis, if the shrinking of the Fed's balance sheet triggers the international financial markets, including the larger stock market down, the shrinking of the Fed's balance sheet is likely to slow down, and even to be reversed. From this point of view, the shrinking of the Fed's balance sheet may not be a simple, mechanical, blind and linear process, but maybe more cautious than the rate hike, with the obvious feature as appropriate decision-making measures.
Influence of Trump's political chaos cannot be underestimated
Trump has been the online opinion leader before the inauguration, and still shows the same temperament after taking office, rather than into the presidential leadership, which results in rounds of farces in the global political arena, especially the US domestic politics. The recent farce is that Trump unexpectedly fired the FBI director who was investigating his relationship with Russia. This is almost the biggest taboo of American politics, and the president seems to be interfering with the judiciary operation. Therefore, no one can guarantee that Trump can pass the next four years smoothly. His ruling process at least in the next year and a half will be extremely complex and difficult. And a year and a half later, with the mid-term election in the United States, Trump's best ruling period may face the end.
If Trump is impeached or his power is heavily constrained by US domestic political turmoil, Wall Street's hard-earned Trump tax cuts and other measures to boost the US domestic economy will be hard to practice. This will certainly trigger rounds of fluctuations in the US financial market. In this case, the US stock market which has been standing at the highest point in history may be most possible to turn downward and quickly adjust. To a large extent, this factor will form a hedge with the capital inflow to the United States to which is brought by the shrinking of the Fed's balance sheet.
In other words, the volatility in US domestic politics will bring great fluctuation in US financial markets. And this fluctuation makes the great reduction of the US dollar to a certain extent. Even if the Trump government can successfully overcome the crisis that the existing FBI director is fired, the Trump government is reluctant to see the formation of the mighty US dollar. And Trump who acts erratically will also seize the opportunity of the re-election of the Fed Chairman Yellen in 2018, to put pressure on the Fed and ask the Fed to adopt a relatively moderate policy to prevent the strong rise of the US dollar.
Extensive adjustment of China's finance
China's financial industry is undergoing a quiet revolution. In terms of monetary policy, the policy authorities do more but say less. What they do is mainly adjust China's macro-financial structure, that is, trying to slow down the growth rate of broad money (M2). The growth of broad money has long been greater than the nominal GDP growth, resulting in the formation of a barrier lake of liquidity in China. The liquidity of the Chinese economy is far more than any one of the world's economies. What the central bank has done is try to slow down the increase in liquidity, including the suppression of rising bank loans. China Banking Regulatory Commission (CBRC), China Securities Regulatory Commission (CSRC), and China Insurance Regulatory Commission (CIRC) are also making the quiet adjustment to clean up the non-performing loans and financial assets that had been formed in the past several years, trying to squeeze out the asset bubbles and clean up those illegal operations.
The overall effect of this round of regulation is to achieve the proper tightening of overall liquidity in China's financial system. In the long run, it is very important to allow the investors in financial markets to truly understand the risks implied in China's financial assets and to allow investors to re-price the risk. But in the short term, this operation will inevitably cause worries or even fears of investors to a certain extent, which may form the pressure of capital outflows.
In this case, many analysts suggest that the Chinese monetary authorities should increase the flexibility of the RMB exchange rate to hedge the pressure of capital outflows. My view is that the Chinese monetary authorities are unlikely to and should not take the so-called easiest way to increase exchange rate flexibility for the purpose of coping with the unexpected consequences of financial reform and the pressure of capital outflows.
In fact, RMB has become one of the world's most-watched currencies in today's world. In this case, the fluctuation of the RMB exchange rate itself becomes an overly interpreted signal. The increase in the flexibility of the RMB exchange rate cannot alleviate the fluctuation of the market. On the contrary, it may become a fluctuating amplifier. It is supposed that when international investors suddenly find the RMB devaluation by more than 2% in a week, the news will quickly spread through the media to every financial market, so that the investors may think that China has the pressure of capital outflows and they will presume that RMB will further depreciate on these grounds. In this case, the fund outflows will be accelerated.
Therefore, in the big layout of financial regulatory reform and China's macro-financial adjustment, the exchange rate policy that is most likely and should be implemented most is to maximize the adjustment at lower pressure and minimize the adjustment at higher pressure. For example, when the pressure on devaluation of RMB against the US dollar is much lower, the flexible space should be appropriately loosened to achieve the appropriate depreciation of RMB; and when there is real devaluation of RMB, the reverse operations should be made to ease the pressure of devaluation through a variety of ways. There is no doubt that accurate capital project management is supported in order to prevent the rush of capital outflow.
The general direction of China's financial reform is to reduce the excessive liquidity of the financial market, while increasing the scale of financial products which are relatively difficult to marketability but play a direct role in the real sector financing, such as corporate bonds, and eligible corporate shares issuance. Specifically, those large companies that are already listed and operating relatively robust can be properly allowed to expand the refinancing, rather than refinancing as they are now. Those mid-cap and small-cap stocks that have not yet been listed should be appropriate to slow down the speed of listing, because the excessively fast speed of listing may result in some listed companies with bad fundamentals in the stock market, which may reduce the quality of stock market in the long run. What is at least done is to ensure the simultaneous delisting and listing, forming a dynamic balance with both forwardness and secession and bidirectional flow.
To sum up the above three factors, the impact of the shrinking of the Fed's balance sheet on the global economic trends is as serious as described by many analysts. It will closely track the fluctuation of US domestic financial markets and the rest of the world, especially China - this has been proved in the observations of recent years. Trump's political chaos has a more direct impact on international financial markets. China's financial adjustment is expected to be relatively cautious, low-key, and pragmatic so that China's financial markets can be stable in this round of international financial fluctuations, and ultimately enhance the depth and quality of China's financial markets, which finally can lay the practical foundation for the international monetization of RMB and the full liberalization for the trading of Chinese financial products.
