Recap on Yuan Depreciation

A look at some offbeat things written here about yuan devaluation over the past few years.

First some recent takes:

July 2015: Currency Devaluation Coming

Bloomberg: China Rattles Markets With Yuan Devaluation
Balding: China Devaluation Thoughts of the Day

I do not believe the yuan devaluation is a one-off move (I started this post two days ago so now, but now it is a three-off move) this is the first step towards a long depreciation trend that will likely turn into a crisis at some point, whether the PBOC does as it says and lets offshore yuan lead the market lower, or if offshore yuan diverges again and the PBOC is forced to deplete reserves or do another catch-up devaluation. I don't think they can put this genie back in the bottle without scuttling SDR hopes and opening themselves up to charges of currency manipulation by U.S. politicians. If China can stop the devaluation at the drop of a hat, then clearly they're allowing it to devalue.

Implication of the drop: Chinese citizens will now expect further devaluation and they can hoard U.S. dollars offshore or find ways to move capital out of China. If the yuan devaluation is large enough that the yuan price in gold rises, Chinese may start buying the metal in bulk again.

Here's a post from 2014 looking for a devaluation: Offshore Yuan Sinks; Major Yuan Devaluation Looms. Of course the yuan didn't devalue, because China didn't allow it.

Here's some posts on how Chinese hoard dollars from 2012: Chinese hoard dollars

China's largest privately run shoemaker, Aokang, exports 40 million pairs of shoes to the United States and Europe each year. Previously, the firm would swap U.S. dollars for yuan on the same day they were received, but now, "[We] keep as much as possible, we even wish we could keep all of it."

...The CEO of Aokang used to ignore the renminbi exchange rate because it was in an appreciating trend versus the U.S. dollar, but now he views it online everyday. Other executives check the exchange rate changes daily.

...A Dongguan shoe exporter has the same strategy as Aokang. Before, they would immediately exchange USD, EUR and JPY for CNY, but now they consider their business needs and the exchange rate before changing money. They slowly increased their retention rate of U.S. dollars from nothing to a current 40%.

Firms are also closing their dollar short positions. In previous years, Chinese firms would borrow in USD in order to benefit from the rising exchange rate and higher renminbi deposit rates. Now, they are reversing these trades and paying back dollar borrowings.

From January 2015 as devaluation talk increased: Do You Plan to Hoard Dollars?

I still think this will be the case: Scramble To Hedge Dollar Bull Will Fuel Rally in 2015, Yuan Bear Market Is Fissile Material

Imagine the explosive bull market in Chinese stocks this year being replayed in the currency market in 2015.

...

“The renminbi is controlled by the People’s Bank of China and no one has enough resources to bet against the PBOC’s foreign-exchange reserves,” he said.

If the psychology in the yuan market tips to bearish, watch out.

I don't think it's a matter of psychology now, but a matter of fact. I haven't seen articles about buying dollars or gold yet, but I expect they'll be coming along soon enough.

From 2014: Yuan Plunge On Tuesday; Anybody Watching the Yuan Price of Gold Besides 1.3 Billion Chinese?. The yuan price of gold is the most important price right now. Chinese citizens can buy gold far more easily than they can buy dollars or foreign assets.

Gold demand was down in the first half: 上半年中国黄金消费下降. Consumption was 561 tons, down 1.4% from a year earlier.

Some argue gold will weaken due to a stronger U.S. dollar. 人民币连接贬值推升黄金 中国需求可能被削弱. The headline, quoting an analyst in the article, says Chinese demand may weaken. I don't think demand will weaken, but it comes down to price. Demand for financial assets rises with the price. If the price of gold in yuan rises, Chinese demand will rise. Also, Kitco: Commerzbank: Currency ‘Devaluation Race’ Should Benefit Gold

From 2014: The Logic of Strategy: Yuan Devaluation and the Road to Trade War

Yuan devaluation is inevitable as soon as China enters a serious financial crisis. If the government refused to devalue, the nation would go through a 1930s style deflationary Great Depression. China is unlikely to allow the market to take the yuan lower in a panic collapse like a replay of 1997. At some point, it would announce a large devaluation designed to end the selling and the crisis. This will be called a political act in the United States (those who understand the economics will nonetheless spot the political opportunity) and the political push for protectionist policies will be too attractive to be ignored. The United States will retaliate with sanctions and the world will follow.

There hasn't been any political fallout yet, but if the yuan continues to depreciate, the calls for retaliation will grow. The popularity of the Trump campaign to this point shows the American public is already ready for a shift on trade; further devaluation would be a "smoking gun" for the politicians. Many nations would follow the U.S. if it led on this issue.

Some Chinese views on yuan devaluation from January: How Yuan Devaluation Affects the Chinese Economy

There is a "coincidence": RMB appreciation nine years, is China's real estate prices continued to rise 9 years.
2005, the RMB appreciation after starting there is a clear signal: the long-term appreciation versus the US dollar.

In theory, there is a lot of dollars into China, into RMB assets, depreciation of the dollar relative to circumvent. After entering these dollars to the existence of some form of assets.

Which is to buy more real estate. One of the reasons prices rose over the past few years is the appreciation of the renminbi. In appreciation of this process, homeowners, people, the rapid appreciation of the assets. Expected real estate appreciation, but also inspire more people desire to buy a house.

If devaluation, investors worried that the withdrawal will be assets of real estate, especially those early influx of domestic funds from abroad, due to devaluation and out of China, or did not dare to easily enter the Chinese market, a variety of factors that boost domestic housing asset prices will go away.

Echoing those thoughts was this hyperbole from back in 2014: Mood In China: If The Renminbi Devalues, Home Prices Will Fall 80%

If you think that's bearish, then try this: Chinese Debate Yuan Risk in the Wake of Ruble Collapse, Liu Junluo Sees Path to 1997 Repeat, Niu Dao Sees Path to Latin American Crisis of 1980s

I've seen some people argue the yuan's move is short-term. I don't think that's the case, this is a major trend change for the economy. Moving The System Into Reverse. The post covers an article by Zhang Mo Nan: Monetary Expansion Trend Changing.

Speaking of a long-term shift, I point you to offshore yuan falling day after day at the end of 2011: Yuan limit down for eighth straight day. The market could easily take the yuan below 7:1 by next week if it wanted to and the PBOC didn't intervene.

The shift from a stable system with very low volatility to one of high volatility is a major one. I found a picture that explains this, it's a chart of the WisdomTree Chinese Yuan ETF (CYB). The change in the price isn't great, but the big move shown on the chart is an exact reflection of how the market feels about this change. You can't look at this in percentage terms, but in the magnitude of that percentage change versus the prior years.

Finally, there's some political speculation. The PBOC has been for tight monetary policy, forcing the economy to rebalance via deflationary contraction in industries with overcapacity. Money has been made available to avoid a crisis, but a permanent state of near crisis keeps people from taking on new speculative debt. (Stock market insanity aside.) In the post Pettis Says China Has 2 Years to Adjust; Xi Must Consolidate Power, there are many links to the political battles that took place between the Xi-Li reform faction, which includes the PBOC, and the business as usual faction which formerly included Bo Xilai and Zhou Yongkang, as well as the Ministry of Finance (which orchestrated the 4 trillion stimulus that is the main cause of financial distress). Devaluation doesn't fit with the program. From March 2015:

Lionel Barber: Premier Li, I have just come from Japan where I spent nine days looking closely at their economic experiment. I met with Prime Minister Shinzo Abe for an hour for an interview. I wonder, are you concerned that the depreciation of the yen and the euro against the renminbi means China is less competitive and you may have to devalue in response?

Li Keqiang: China has been advancing the reform of the Rmb exchange rate formation mechanism to widen the Rmb floating band and improve the market-based, managed exchange rate regime. For some time, there has been slight devaluation of the Chinese currency. But this is not because of the steps taken by the Chinese side, but because of a stronger US dollar. I believe the current value of the Rmb is basically stable. We don’t want to see further devaluation of the Chinese currency, because we can’t rely on devaluing our own currency to boost export. Instead, what we need is to boost our domestic demand. Otherwise, it will be difficult for us to adjust our economic structure. We don’t think companies in China should mainly rely on a devalued Chinese currency to boost exports. Instead, they should focus on enhancing their competitiveness by raising the quality of products and making technological innovations. At the same time, we hope that all major economies will enhance co-ordination on macroeconomic policies. We don’t want to see a scenario in which major economies trip over each other to devalue their currencies. That will lead to a currency war. And if China feels compelled to devalue the Rmb in this process, we don’t think this will be something good for the international financial system. This may ultimately lead to trade protectionism and impede the globalisation process. This is something we don’t want to see.

I would highlight Li's quote, but I'd have to highlight the whole thing. First, he lays out the policy I outlined above: tough love for the Chinese economy. Make the tough choices and don't rely on devaluation or easy money which leads to more problems later. He also says devaluation is to be avoided because it could trigger trade wars. Speaking of which: Japan PM adviser Hamada: Japan can offset yuan devaluation by monetary easing

If there's some politics at play, it could be the anti-reform faction is getting frustrated/scared by the extent of the economic slowdown. When the tide goes out, you see who's been swimming naked, and in Xi's China, that could mean a corruption charge. Anti-corruption aside, pressure to do something is likely mounting given the data coming out, such as the northeast recession. Devaluation could be a gesture for these frustrated CCP officials, or it could be a sign that the reform faction is losing power.

Or it could be this is all part of the SDR push and got out of hand. It seems every government these days believes its own propaganda. Chinese officials may think the yuan is nearly invincible and not just another over-inflated fiat currency due for a adjustment.

In conclusion, the chart I lean on most is the change in reserves versus the change in CNY/USD. It points to devaluation as reserves decline, and reserves should decline if China is to rebalance to domestic growth. Or decline simply because nothing goes up forever. From the Zhang Mo Nan article linked above:

Long period of evolution of the monetary and financial policy makers biggest implication is that to avoid asset bubbles out of control, strengthen financial stability mechanisms and measures. From the world experience, several major monetary and financial cycles are based on asset bubble burst, even in the form of the financial crisis to complete the transition.

Currency crises also complete a transition.