China’s Looming Currency Crisis

The Yuan strengthened against the Dollar, breaking support at 6.50 (USDCNY) as Chinese authorities attempt to squeeze short-sellers. But the primary trend is unchanged and warns of further weakness.

From Anne Stevenson-Yang and Kevin Dougherty at WSJ:

After initial declines in the Chinese market to start the year, the past few weeks have seen signs of what some would call a rebound. Lending in China rose by 67% in January, iron-ore prices initially rallied by 64% and housing sales in the top four markets surged…..

Chinese authorities have been trying to bring back the old, quasisuperstitious belief in Beijing’s omnipotence. But the political desperation behind these efforts betrays a different story: that an impending currency crisis is a signal of the dream’s undoing. That’s why in China getting money out of the country is now the major preoccupation of both families and corporations.

One way to stem the crisis would be through depreciation. That would be sound policy for the people of China, but it’s a dreaded last resort for a leadership that wants, more than jobs for its people, to bolster buying power and save political face overseas. Yet history shows that holding the line on the currency is a losing strategy. Tightened liquidity causes more pain to the economy and simply delays the inevitable.

In other countries, currency crises usually followed a sudden and irreversible loss of confidence. The Asian Tigers were booming and then fell apart rapidly. Same in Russia. China faces the added difficulty of having little institutional memory and few tools to manage the economy in a time of capital scarcity. And there is no sign that capital-outflow pressure will ease.

From David Llewellyn-Smith at Macrobusiness:

The macro logic here is impeccable and Ms Ms. Stevenson-Yang knows China better than most. I actually think that Chinese officials already understand this and the current back and forth on yuan policy is them searching for a way to do it in a manageable glide slope rather than crash.

I agree that China faces a currency crisis. I lived through one in South Africa in the 1980s and recognize the signs: purchase of offshore homes, local companies bidding for offshore acquisitions, over-invoicing, local residents using ingenious methods to avoid capital controls…..

This graph of the US Dollar/South African Rand exchange rate from Wikipedia covers the early alarm in the 1980s, when the Rand fell from parity against the greenback, through to the current “Zuma-gate” when the Rand hit 15 to the Dollar in late 2015:

Capital controls are too late. The horse has bolted. Trying to prevent Chinese residents from moving their capital to a safer climate is as effective as herding cats. The only way depreciation can work is “shock and awe”: a massive once-off devaluation of the Yuan. Gradual weakening of the currency will simply reinforce the panic.

I shudder to think of the effects a dramatic fall in the Yuan would have on global capital markets. Chinese companies would be forced to default of USD-denominated debt. Trading partners, including the US and Europe, would be forced to respond with competing devaluations to avoid the contagion. I think (and hope) that Chinese officials have been persuaded that this is not an option.

….Which leaves capital controls, and eating through China’s $3 trillion plus of foreign reserves to support the Yuan, as the least-worst option. Or is that simply kicking the can down the road?

Source: China’s Looming Currency Crisis – WSJ

Hat tip to David Llewellyn-Smith at Macrobusiness.