China Blames Fed for Stock Market Rout

August 28, 2015 Updated: August 29, 2015    

When times are good, there is no reason to point fingers. When times are bad, there is still no reason to point fingers, but usually people and institutions alike do it anyway.

Case in point is an unnamed Chinese central bank official who blamed the Fed for this week’s epic market volatility. According to Reuters he said you “can’t blame yuan devaluation for global market turmoil” and that the Fed should delay a rate hike much anticipated for September.

One would usually dismiss such claims coming out of China rather easily, but in this case the central banker might have a point.

We have previously reported that the market forced the People’s Bank of China (PBOC) to let the yuan devalue 3 percent in mid-August because of a severe global dollar shortage.

The dollar shortage came about because the Fed ended its expansionary QE policy late in 2014, making dollars relatively scarce on world markets.

This led to the unwinding of the infamous carry trade where speculators borrow dollars and invest them in higher yielding currencies, such as the yuan. Because of fewer available dollars for such operations, the speculators starting withdrawing funds from Brazil, Turkey, and also China and moved them back onshore.

This of course did put pressure on the yuan and the PBOC had to start selling parts of its foreign exchange stash ($317 billion since last August) to keep the currency stable.

After the Fed indicated it would even raise interest rates this year, this reverse flow of dollars intensified and forced the PBOC to let the currency lose, albeit only a little bit.

Because traders have to unwind their positions out of necessity—often associated with losses—they just pay back their loans and remain on the sidelines, leading to a general “risk-off” environment as seen during the last few days.  

So yes, the Fed is at least partly to blame. However, China is not without fault.

The carry trade unwind was so forceful because China has been mismanaging its economy for such a long time, blowing up bubbles in real estate and the stock market which subsequently burst. In addition, it kept on micro managing its exchange rate, accumulating an unhealthy amount of foreign reserves, which is now coming back to haunt it.