The Peoples Bank of China has spent US$300bn in the last three months

Money is still pouring out of China. In January, the Peoples Bank of China (PBC) spent US$100bn of its foreign exchange reserves trying to prop up the Renminbi following December’s outflows of US$108bn.

Investors rattled by the economic slowdown are fleeing the country and the government is concerned that if it lets the Renminbi fall in value it could trigger another round of currency wars. China would like to avoid any retaliatory devaluation by trading partners that would lead to widespread deflation as this would greatly increase the cost of servicing the US$1.2tr of dollar denominated debt held by Chinese companies.

China’s foreign currency reserves have fallen to a four year low trying to prop up the Renminbi. Unfortunately, the vast amount of money spent has achieved very little as market sentiment is firmly against the Renminbi. It is this market sentiment that is encouraging currency traders to short sell the currency.

A major issue is the flight of capital from china but perhaps more important is what this money is being used for. The PBC has spent US$300bn in the last three months. At this pace it is just four months away from reaching the IMF adequacy level of US$2.8tr. If the outflows are largely to pay off US$ denominated debt then this is both useful and beneficial particularly if the US does reduce dollar liquidity. There is evidence that this is the case as the Bank of International Settlements stated that US$ liabilities of Chinese companies peaked at US$1.1tr in late 2014, fell to US$877bn in September 2015 and now stands at US$500bn.

It would be much more concerning if capital flight was due to a lack of confidence in the Chines authorities in general. Such an outcome could overwhelm the PBC exchange rate defence and trigger a currency run sending a deflationary wave across the world.

There is some evidence that China’s economy is stabilising. The service sector continues to grow in both importance and size. Chinese service sector PMI figures grew in January to 52.4 up from 50.2 in December. The same figures that prompted the equity sell off in the first week of January. This strengthening of the service sector will help offset the ongoing weakening of their manufacturing sector.

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