On the heels of China’s move to devalue the yuan on August 11, the market’s attention abruptly shifted to something we’d been discussing for quite some time. Namely, China’s rapidly depleting FX reserves.

The problem for China was that they wanted to devalue, but they wanted to do it on their terms and that’s not something that was particularly agreeable to the market. What was immediately apparent to us, but what it took weeks for most observers to understand, was that the PBoC actually transitioned to an FX regime that afforded the market less of a role in determining the exchange rate, not more. Before, China would reset the daily fix to dictate where the spot traded. In the new system, the PBoC simply manipulates the spot in order to dictate the fix, which from August 12 was supposed to “better reflect” the previous day’s trading. But if the previous day’s trading was dictated by PBoC intervention, then the entire endeavor is meaningless.

Of course daily spot interventions cost money. Lots of it. Especially if the market smells a rat and thinks you may be angling for a larger devaluation down the road but are unwilling to just rip the band-aid off and move to a free float now.

China blew through nearly $100 billion in the month of August alone supporting the yuan and soon enough, FX reserve data out of Beijing became the market’s new risk on/risk off trigger. The data also became a rather public proxy for capital flight and before long, China got uncomfortable with the amount of attention the headline figure received.

So, the PBoC decided to find other ways to intervene to both support the onshore spot and ensure that the CNY/CNH spread didn’t widen too much (the weaker the offshore yuan trades relative to the onshore spot, the more depreciation pressure there is). Dabbling in forwards became one of the bank’s go-to strategies.

What Beijing has been doing actually isn’t all that complicated. The PBoC simply asks policy banks to borrow dollars in the swap market, sell them, and then enter into a forward contract with Beijing which effectively squares the trade for the banks as the PBoC takes everything onto its own balance sheet.