The financial crisis taught the world a lot and among those lessons one proved more important than the rest; that banks and financial institutions of the developed world were severely under-capitalised. They were leveraged to the hilt, investing profits at the expense of saving and it left them with far too little in the coffers to help them survive a period of terminal market decline. After the devastation to both the industry’s operations and reputation it became evident that, if banking as we knew it was allowed to continue, these capital reserves could never again be allowed to slip to such unsatisfactory levels. Off the back of this, Basel III replaced its preceding brothers to form the greatest pillar of post-crisis legislation for banks. Federal Reserve counterparts followed suit swiftly after with legislation on perceived credit risk and leverage ratios. It’s amazing then that seven years on, nations around the world have decided not to adhere to the same strict guidelines they enforced on their respective financial industries. Heeding none of the same warnings, the world’s largest economies are sitting on crumbling reserves, evaporating in the face of crisis and recession.
In the aftermath of arguably the world’s worst financial crisis China stood as a Titan on top of vast reserves and was a saviour to many western nations who had little or none. In doing so and in attempting to revive its economy with blanket injections of stimulus it did, however, accumulate as yet unseen levels of debt that are now proving a thorn in its side. The world’s second-largest economy has sleepwalked into an era of debt, as total levels tripled from 2009 to $31.7 trillion in 2015 according to Bloomberg BusinessWeek. China bulls continue to argue the economy’s continued effort to lend and borrow a sign of corporates willing to invest in a low-interest rate environment, but when you consider the majority of these institutions are simply state-owned companies taking out loans from the state-owned bank it paints a disappointing picture. Bloomberg estimates just under $25 trillion of the current debt in China is government debt, and the repayments alone are eroding China’s vast reserves.
Beijing’s foreign-exchange reserves dropped an unprecedented $107.9 billion in December 2015 alone, completing a consecutive run of falling every month since May of that year, and it’s not just the debt that’s troubling the PBOC. The yuan is split into two currencies; CNY, the official exchange currency for the mainland and the CNH, an offshore deliverable currency in Hong Kong. Beijing historically has influenced CNY through the sale and purchase of US dollars and in previous years, it’s had a lot of those to hand. Fueled by inbound investment from American investors and the nation’s massive export volumes, the exchange was easy to manipulate. Now, however, with the economy entering a phase of structural transformation and lower growth, China is facing huge capital outflows as investors clamber over each other to change yuan into dollars. The easiest way to do this, of course, is with CNH, the offshore deliverable currency and this has created a huge gap between the onshore and offshore exchange rates. The PBOC is channeling reserves daily into closing this gap to stem capital outflows and silence currency speculators, but it’s unclear what the cost to its reserves will be by the time it finishes this campaign.
Beijing has one arrow in its quiver that others do not, and that’s the sheer size of its reserves. They cast a shadow over the majority of other nations available capital, even when combined, and are four or five times the size of the world’s largest sovereign wealth funds. One such fund, Saudi Arabia, is in just as much trouble as the PBOC when it comes to depleting reserves. Low oil prices not seen since the previous oil supply crisis have dragged heavily on the economic prospects of the OPEC heavyweight. At the end of 2015, Saudi Arabia announced a record budget deficit and a projected shortfall for the following year as well. Further austerity measures have been implemented, and the government is underway with a bond offering to support the struggling economy, but reserves are suffering, and there doesn’t seem to be any plug to the leak. Saudi Arabia is hellbent on producing crude oil at maximum capacity to squeeze out high-cost producers, but the supply war is forcing prices to lows where even the world’s top oil exporter is feeling the pain. Reserves dropped from $732 billion in 2014 to $628 billion in November 2015, but this is down from nearly a trillion no more than five years ago.
The bottom line; the economic and political wars that are being fought right now, whether that be a currency war between the developed nations or a commodity price war between oil exporting nations, are draining the reserves the world vowed to keep strong should they ever face a crisis like 2008 again. To take out debt, someone first has to have the money to lend.