China is pumping a lot of cash into its economy to calm investors
China injected nearly $130 billion into its market in the last two weeks to quell a bond rout
The People’s Bank of China is seeking to balance market sentiment with its need to crackdown on debt
Rapidly expanding liquidity could make it more challenging for Beijing to counteract capital flight — its relatively static foreign exchange reserves are growing less potent when compared to the amount of cash that could be leaving the country
China has been pumping a lot of cash into its system to lift market sentiment, as the world’s second-largest economy walks a thin line between curbing debt and keeping everything running smoothly.
Last week, the People’s Bank of China injected cash totaling 810 billion Chinese yuan ($122.4 billion) in five straight days of daily liquidity management operations. Those actions, which represented the largest weekly net increase since January, were in part a Beijing response to its 10-year sovereign bond yields spiking to multiyear highs, experts said.
“Surging Chinese government bond yields hit the nerve of policymakers, so in order to further prevent a greater surge, they injected liquidity into the system to improve market sentiment,” said Ken Cheung, a foreign exchange strategist at Mizuho Bank who focuses on Chinese currencies and monetary policies.
Nomura analysts said last week in a note that the bond rout was due to fears of regulatory tightening from Beijing. Bond yields, which move inversely to prices, briefly hit 4 percent in China for the first time in three years.
A rise in the benchmark government bond yield threatens to drive up overall borrowing costs — and potentially worsen the country’s debt situation.
On Monday and Tuesday of this week, the PBOC injected a net 30 billion yuan ($4.5 billion), but it didn’t expand that money supply on Wednesday. Analysts said that pause may have been due to market sentiment seemingly stabilizing, but it may be short-lived.
As Chinese 10-year yields are still near the psychologically important 4 percent level, Cheung told CNBC he expects more injections ahead if necessary, as Beijing needs to “maintain liquidity to please the market.“
The PBOC’s daily cash injections is done through the issuance of reverse repurchase agreements, or reverse repos. That’s a process by which the central bank buys securities from commercial banks with an agreement to sell them back in the future at a higher price.
Conducted through open-market operations — daily, in the case of China — repos are a common money market instrument used for short-term funding between banks around the world.
The PBOC relies on those operations to manage liquidity, but Mizuho’s Cheung said the central bank will keep expanding its toolbox in the future.
Despite the recent moves, the PBOC will keep a cautious stance, analysts note, as authorities continue to balance growth and debt deleveraging.
In fact, the PBOC highlighted in its third-quarter monetary policy report the need for financial stability and reiterated prudent management of the economy.
“We read this as a sign that financial deleveraging will be a multi-year theme and that deepening financial reforms are underway,” Nomura analysts said in last week’s note, adding that the market is pricing in maintenance of a prudent monetary policy stance.
Indeed, the PBOC drained a net 465 billion yuan from the money markets through open-market operations from the beginning of the year until November 10, Reuters calculations show.
Beijing officials have been outspoken recently about financial risks in the country, which is beset by high levels of debt, and investors are worried about a domino credit event unfolding. That being the case, it makes sense for the central bank to want to avoid overheating the economy with too much cash.
How Chinese liquidity can go very wrong
Even though many investors believe the financial risks in China are controlled due to its strong top-down control, the world’s second-largest economy is still subject to external risks that can cause a crisis.
One factor that’s making China more susceptible is the fact that its money supply has been growing at a very rapid pace while its foreign exchange reserves stay basically static.
“With the foreign exchange reserve being relatively fixed, foreign exchange reserve as a share of money supply has fallen from 40 percent just five years ago to 10 percent today,” Victor Shih, a professor and China expert at UC San Diego, told CNBC.
The foreign currency reserve is a primary tool for managing currency values — an important issue for China — and the increasing base of liquidity should continue to dilute its power, Shih added.
Over time, as the ratio declines, it will get harder for the FX regulator to counteract capital flight: Beijing keeps money in its system (and the yuan strong) by buying up its currency in international markets with its horde of foreign cash. So if there’s more RMB to buy, then the reserves won’t go as far. Shih suggested such a situation could eventually “wipe out” the reserves entirely.
That would leave Asia’s largest economy exposed to outside shocks.
“That is a great weakness of China, it’s something external, especially if we have things like multiple rate hikes in the Federal Reserve,” Shih said. 
China’s leading sovereign wealth fund is eyeing an office in California.
Leading Chinese financial institutions are slowly increasing their physical footprint in Silicon Valley, mirroring the moves made by Middle Eastern investors in recent years as foreign countries look to capitalize on the U.S. tech boom.
The two central players at this point:
The China Investment Corporation, or CIC, a sovereign wealth fund which manages over $800 billion on behalf of the Chinese government
“CIC is not to be confused with the other force, CICC, or the China International Capital Corporation, a Chinese investment bank formed in 1995 that is the nation’s first brokerage and is sometimes called “the Goldman Sachs of China.”
CICC has begun a $500 million U.S. venture fund, the first of its kind, and has opened an office in San Francisco to locate and invest in promising tech companies. The bank, which previously only had a space in New York, celebrated its new office this month at a forum that effectively announced to international investors that they were open for business.
Now, the Chinese sovereign wealth fund is mulling a plan to take similar steps, according to multiple people familiar with CIC’s thinking. CIC has told several U.S. investors in recent weeks that it has a mandate to do more direct investing in startups, especially in later-stage companies. The fund is staffed heavily by former bankers and has primarily invested in several of Silicon Valley’s most elite venture capital firms as a limited partner (though it has made some direct U.S. investments in the past, like in Airbnb).
CIC is increasing its U.S. footprint with on-the-ground staff, and two sources said the sovereign wealth fund wants to eventually open a physical office to oversee their direct investments, though it is not expected imminently.
CIC spokesmen did not respond to repeated requests for comment from Recode in recent weeks.
The arrival of the CIC behemoth in Silicon Valley would be China’s latest attempt to deepen its investments in the United States. The sovereign fund, created in 2007, had an office in Toronto until 2015, its first post overseas, before retreating out of Canada after that country’s energy sector disappointed them. This past May, the CIC opened a space in New York, its first U.S. office.
A second post would show how seriously the CIC specifically plans to take direct investing in tech. CIC could also eventually start a dedicated venture fund, as CICC has.
But the moves would likely draw attention from U.S. regulators, who are already unsure of Chinese investors’ ambitions in the sector. China’s relationship with the Trump adminstration seesaws daily.
Other sovereign wealth funds with shops in Silicon Valley include Temasek of Singapore, Khazanah Nasional of Malaysia and Mubadala of Abu Dhabi, which just opened its space and a U.S. venture fund this month.