TheChek News Flow

Beijing turns to measures not used since global financial crisis as currency strengthens

China is resorting to measures not used since the global financial crisis to temper a rally in its currency as the country battles rising global commodity prices and slowing economic growth.

A move by the People’s Bank of China that will force lenders to hold more foreign currency indicates that policymakers want to rein in the renminbi’s gains after it touched its strongest level against the dollar in three years last week. That marked a reversal from the years of the Trump administration, which labelled Beijing a currency manipulator in 2019 after the renminbi weakened past the important Rmb7 per dollar level.

The central bank action, announced late on Monday, will raise Chinese financial institutions’ required reserves from 5 to 7 per cent of total foreign exchange deposits “in order to strengthen foreign exchange liquidity management”, according to the PBoC.

That marks the biggest such increase ever, analysts said, and the first since the global financial crisis. The strength of the renminbi has created a further headache for policymakers in China already grappling with soaring commodity prices and risks from high amounts of leverage across the economy.

China’s currency has strengthened almost 11 per cent against the dollar over the past 12 months. The onshore-traded renminbi was little-changed at Rmb6.3696 per greenback on Tuesday but analysts said more interventions in currency markets were likely.

“The move aims to cool down the onshore renminbi’s rapid appreciation by reducing [foreign currency] liquidity in the system,” said Becky Liu, China macro strategist at Standard Chartered, which estimated that the rise would sap about $20bn of liquidity from the country’s foreign exchange market.

The requirement will restrict the domestic supply of foreign currencies, making it harder to use dollars to purchase renminbi onshore, potentially easing demand for the Chinese currency.

“The PBoC’s action highlighted its stance against the rapid renminbi appreciation and hints [at] further forthcoming measures,” said Ken Cheung, chief Asian currency strategist at Mizuho Bank.

However, some policymakers in China have argued in favour of a stronger renminbi. A PBoC official this month wrote an editorial, which was subsequently deleted, arguing that the central bank should let the currency appreciate to counter surging global commodity prices. A stronger Chinese currency could make its imports of overseas raw materials cheaper.

Higher commodity prices have pushed up factory gate prices in China and stoked fears of inflation. A cabinet meeting chaired by Premier Li Keqiang last month said measures should be taken to stop inflation of producer prices, which rose 6.8 per cent in April, passing through to consumer price inflation, which remains low. Producer prices fell throughout most of 2020.

There are also signs that China’s strong economic recovery from Covid-19 is cooling off. On a quarter-on-quarter basis, the economy expanded just 0.6 per cent in the first three months of the year, according to the National Bureau of Statistics, well below expectations.

China’s exports, which in theory benefit from a weak renminbi, have boomed over the past year despite the currency strengthening. Exports rose 32 per cent year on year in dollar terms in April, reflecting China’s dominance of global trade given its rapid recovery from the pandemic.

However, “the broad renminbi strength will likely undermine the competitiveness of China’s export sector”, Cheung added.

Does China’s Baby Bust Mean a Global Inflation Boom?

The effects of China’s demographic crisis will percolate to nearly every corner of the global economy

One of the biggest effects could be on something that is very much already on companies’ minds these days: inflation.

Of course, a significantly smaller Chinese labor force wouldn’t necessarily mean higher prices for labor-intensive consumer goods. That would also depend on demand, levels of automation, transportation technologies and many other things. But all things being equal, it does seem likely that costs for labor-intensive manufacturing in aggregate could be set to rise significantly over the next decade or so, particularly if India continues to struggle with poor infrastructure and protectionism. Places like Vietnam will help, but the scale is several degrees of magnitude away. China’s Guangdong province alone is home to around 30% more people.

One reason China’s integration into the world economy had such an enormous impact on the price of labor-intensive goods was that it timed its opening to the world nearly exactly right demographically. From 1990 to 2010, the percentage of the nation’s population ages 15 to 64, already reasonably high, skyrocketed nearly 10 percentage points to 75%.

Not only was an enormous and cheap labor force suddenly available to multinational producers, but that labor force in aggregate had relatively few dependents to care for. Workers were more open to taking risks and chasing work opportunities far away in the big coastal cities.

Increasingly, however, that is no longer the case. About half of migrant workers in China are older than 40, according to Commerzbank, compared with around 30% in 2008. Many of them will find themselves responsible for supporting two elderly parents back home.

The growth rate of both the migrant and overall urban labor force has slowed sharply since 2017, right around the time the 15- to 64-year-old population began to fall in earnest. That is a more worrisome trend than lower population growth itself. It implies that one main source of Chinese productivity growth—moving workers from low-value-added agriculture or local services into high-value-added manufacturing—may be starting to bump up against some natural limits.

Even before the hit from Covid-19, official data showed that the growth of the urban workforce had dipped below 10 million in 2018—the first time that has happened since 2002—and that trend continued in 2019. Survey data also shows that the ratio of urban jobs available to urban workers has marched steadily higher since 2017.

An older, slower-growing population could also feed into commodity prices in important ways. For now, Beijing’s need to show rapid progress on carbon emissions has translated into forced steel-supply cuts, higher prices and headaches for industrial commodity buyers. But over the next two decades, an older population with scarcer savings might be less inclined to plow its hard-earned money into new apartments and more interested in fixed income with reliable cash flows, especially if Beijing bites the bullet on overhauling financial and capital-account rules.

That would hit not only steel, but also copper demand. Many investors seem to view copper as a sure thing given the tailwinds behind investment in clean energy and vehicles. But as of 2018, construction was still the biggest source of copper demand in China, according to mining giant BHP, accounting for 26% of total demand and edging out the power sector and consumer durables at 22% and 23%, respectively. If future Chinese households stop seeing real estate as their best financial bet, the hit to demand for nearly every major industrial commodity would be substantial.

Inflation is, as central bankers are once again discovering this year, a tricky beast, and in the Western world at least, services tend to be as or more important for consumers.

But unless China’s efforts to automate and expand the labor pool prove more effective than expected, labor-intensive manufacturers everywhere might find themselves feeling the squeeze in the years ahead. And many commodity producers could find themselves with fewer customers than expected, too.

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Investment banking fees from US blank-cheque companies have tumbled as market has cooled

The fees US banks earn from special purpose acquisition companies have plunged in the past two months, disrupting what had been a main profit generator on Wall Street.

Investment banks made a little over $430m from initial public offerings of Spacs and mergers between Spacs and private companies in April and May, according to data from Refinitiv. That accounted for 4.5 per cent of overall investment banking fees for the period.

By comparison, in January and February, Spacs accounted for 22.5 per cent of revenues and brought banks almost $3bn in fees — the two most active months ever for the sector.

Spacs raise money in an IPO and then hunt for an operating business to acquire. They became one of the most popular investment vehicles on Wall Street last year, attracting participation from the likes of Bill Ackman, Serena Williams and Alex Rodriguez.

Investor enthusiasm has waned, however, following lacklustre share price performances after recent deals and a newly sceptical approach on the part of US regulators, which have questioned Spacs’ accounting standards and forecasts for future earnings.

As a result of the slowdown, fees now lag behind the rate seen in the second half of 2020, when Spac work generated around 10 per cent of total earnings. Current levels are closer to those typical for Spacs prior to mid-2020.

“Year-to-date volumes in the Spac IPO market through April 2021 exceeded the Spac IPO volumes in all of 2020, which had dwarfed 2019 volumes, so it is somewhat understandable that it is taking time for the market to absorb all of these deals,” said Mark Brod, a partner at Simpson Thacher.

In April and May, there were only 30 US Spac IPOs, compared with 299 in the first quarter, Refinitiv data showed. In the same two months, 32 Spacs agreed mergers, compared with 84 in the first three months of 2020.

There are still 422 Spacs that have raised a combined $134.4bn currently searching for a company with which to merge, according to industry tracker Spac Research.

Spacs typically have around two years to agree an acquisition and the deal slowdown has quickly fed through to the IPO market. Some specialist investors, usually hedge funds, buy into Spac IPOs and sell after a merger is announced, so delays caused by the extra regulatory scrutiny have kept money tied up that would otherwise be used to back new offerings. The leverage available for that trade has also been cut.

Share prices are not typically rising as much after deal announcements now, either, further limiting the money that can be recycled.

Six Spacs announced deals last week, according to Spac Research data, including for savings start-up Acorns and Tritium, a maker of chargers for electric vehicles. Shares of all six are trading below their IPO level.

Some bankers remain hopeful of a rebound, particularly if the wider pullback in technology sector valuations reverses.

“In mid-February . . . investors were seeing a lot of alpha in the Spac market. Now the merger index has retraced,” said Paul Abrahimzadeh, co-head of North America equity capital markets at Citi, which has worked on more Spac IPOs this year than any other bank.

“That can change quickly depending on secondary market valuations in the sectors where Spac merger activity is most pronounced.”

German carmaker balked at bill for fitting group’s telematics despite production threat

Daimler has agreed to buy 3G and 4G licences directly from Nokia, ending a long-running intellectual property dispute that could have forced the German group to suspend the production and sales of its cars and trucks.

The Mercedes-Benz maker had been sued in several German courts for refusing to buy licences for the technology that connects in-car navigation and entertainment systems to the internet and underpins semi-autonomous driving capabilities.

While rivals such as VW have bought licences, the premium manufacturer had balked at the cost, arguing instead that Nokia should license suppliers such as Continental and Bosch, who build the telematic control units in which connected technologies are housed.

In its legal filings last year, Nokia maintained that it offered Daimler a fair price for the licences and that it was entitled to recoup the billions of euros spent on the development of its inventions.

A series of judgments last year went against Daimler that, if enforced, could have prevented the manufacturer from building or selling cars equipped with tech relying on Nokia patents. But Nokia chose not to pay billions of euros in bonds to enforce an injunction before appeals against the verdicts were heard later this year, including one referral to the Court of Justice of the EU.

Daimler’s decision to settle the case brings an end to all legal proceedings between the two companies.

“The agreement is a hugely significant milestone which validates, once again, the quality of our patent portfolio, the contribution of Nokia’s R&D to the connected vehicle industry, and the growth opportunities for our automotive licensing programme,” said Jenni Lukander, a president at Nokia Technologies.

In a one-line statement, Daimler, which has a large manufacturing base in Germany, said: “We welcome the settlement — from an economic point of view and because we avoid lengthy juridical disputes.”

Neither party revealed the financial terms of the agreement.

Nokia still faces a separate legal fight with Continental in US courts.

The Dax-listed supplier, which along with Bosch supported Daimler’s case in the German courts, has also lodged a complaint with the European Commission, arguing Nokia is abusing its dominant market position.

Nokia, which prefers to license the end-product rather than the component manufacturers, claims it has “continually made fair offers for licensing, providing a range of flexible approaches — direct to automakers, to tier-1 suppliers and through a collective licensing pool alongside other players in the industry”.

However, Continental maintains that these offers were not fair, reasonable and non-discriminatory. “Nokia made a promise to license anyone, but they are not keeping that promise,” a person close to the company said.

With so-called “over the air” updates to software in cars becoming ever more important, German parts makers are concerned that Daimler’s settlement might provide a worrying precedent that might harm the competitiveness of companies in Europe’s largest economy.

The companies, who also sell connected devices, want to be able to offer a fully licensed product to their customers.

“German courts tend to grant injunctions even if the party that is sued does not manufacture the product, and has not been offered a licence,” the person added.