The Chinese currency situation can be boiled down to a few bullets:
- Concerns about the trajectory of Chinese economic growth
- Fears of a large scale devaluation waiting in the wings
- Capital is fleeing from the country at an alarming rate
- Yuan value is weakening due to all three above
- PBOC is spending nearly $800bn a year to slow the weakness
- PBOC can’t raise rates, doing so would further slow the economy and further complicate an already massively overlevered economy
- PBOC can’t cut rates, this would exacerbate capital flight out of the country
Seems the logical solution is some effort to limit both the avenues to and volume of Yuan convertibility. Simply put, force more Chinese to hold more Yuan.
Believe it or not, the World’s bankers, agree! At Davos, BOJ’s Kuroda and IMF’s Lagarde were essentially on record supporting Chinese capital controls!
Draghi would very likely support some strengthening of the Yuan to make his job of weakening the EUR easier and further incent purchases of European goods. Yellen would certainly applaud some stability in the Yuan to reduce USD strength and make the Fed’s 4 hike “mission” in 2016 a bit more palatable.
This is certainly bullish for BTC!
A second order trade consideration is the impact on the Yen.
- China implements some additional degree of capital controls, somewhat strengthening the Yuan = Weaker Yen. Less incentive and more difficult for BOJ to implement additional easing without stirring Chinese concerns of a predatory competitive devaluation.
- China unleashes a major “one fell swoop devaluation” = Stronger Yen. BOJ’s hand forced and with focus entirely on China as sole “bad actor,” BOJ will have a free pass at a much expanded QQE program.
- China continues on it’s current path of a “managed devaluation” = Continued Yen Strength. Larger incentive for BOJ to implement additional easing. Yet, no reduced risk of Chinese backlash from competitive devaluation fears. More global pressure required, before BOJ has “global blessing” for expanded QQE.
Scenario three is the most likely outcome. Poorly conceived and hastily implemented selling bans and circuit-breakers evidence the narrative of the Chinese fumbling in the dark to manage a collapsing market. With a first-mover advantage – they’ve been selling Treasuries, well under the radar, for some time, it’s hard to believe the Chinese powers that be and their advisors couldn’t have envisioned the current predicament as a possible challenge. The Chinese are playing the long game. They’re not a public company with a mandate to manage expectations on a quarterly basis. The country is largely still united by a societal good over individual gain mentality that lends quite a bit of endurance for additional pain. A managed devaluation is in their best interest and they still have ample resources – conventional and un-conventional, to manage the Yuan, longer than most expect.