A man checks Chinese yuan bills in Beijing on July 28, 2015. The yuan is declining against the dollar and bitcoin as Chinese move money out of the country. (FRED DUFOUR/AFP/Getty Images)A man checks Chinese yuan bills in Beijing on July 28, 2015. The yuan is declining against the dollar and bitcoin as Chinese move money out of the country. (FRED DUFOUR/AFP/Getty Images)

The Chinese currency, the yuan, is a strange animal. Linked to the dollar, it hardly moves—but when it does, financial markets get jittery, especially when it’s going down.

The yuan lost 1.1 percent against the dollar in October, which doesn’t seem like a lot. It’s what’s behind the one percent move that has markets on edge.

According to investment bank Goldman Sachs, as much as $500 billion in capital has left China this year through September. Chinese companies and citizens, as well as foreigners, convert their yuan holdings into dollars and other foreign currencies, moving the price of the yuan down. Outflows picked up especially in September, reaching $78 billion.   

gsyuanoutflow

If there is no additional demand for the yuan from trade, for example, the price of the currency has to move down to adjust for the imbalance in the demand for foreign currency. Fundamentally, this is a vote of no confidence in the Chinese economy. If risks and returns of Chinese assets were favorable—as they were for most of the past decade—capital would be flowing into China and not out.

Regime Meddling

However, the Chinese leadership wants to limit the visibility of this vote of no confidence and give the impression of financial stability, so it is applying two levers to obscure the move.  

First, it is selling off its once mighty stash of official foreign currency reserves, down from $3.33 trillion in January to $3.17 trillion at the end of September. In August of 2014, it was close to $4 trillion.

It is simply a transfer of public Chinese foreign exchange assets to private hands intermediated through global financial markets. If the amount of foreign currency bought by the private sector and sold by the official sector matches, the impact on the price of the currency is limited.

For example, Chinese official holdings of U.S. Treasury bonds are down from $1.25 trillion at the beginning of the year to $1.19 trillion at the end of August. However, Chinese corporates have either completed or announced $218.8 billion in mergers and acquisitions of foreign companies this year, according to Bloomberg data.  

(Bloomberg)

(Bloomberg)

The rest of the record corporate buying spree was financed by Chinese state banks and other foreign exchange reserves held at the People’s Bank of China (PBOC).

Chinese companies have previously invested in steel mills and coal mines like there is no tomorrow. However, because mining and manufacturing have massive overcapacity and debt issues, Chinese companies are looking overseas for better investments.

But it’s not only Chinese corporates that are suddenly discovering the value of foreign assets. Chinese citizens have also been active buyers of foreign real estate and stocks. Purchases of equities traded on the Hong Kong stock exchange by mainland citizens, for example, hit a record high of $12 billion worth of buy orders in September, up 64 percent from August.

Capital Controls

So the Chinese regime is pulling the second lever to limit outflows: capital controls. Transfers of capital for citizens are already capped at $50,000 per year, so people found nifty ways around this limit. Like buying millions worth of life insurance products, a form of capital investment, in Hong Kong for example with their Union Pay debit card. But not anymore.

As of October 29, they can only use their UnionPay cards to buy insurance related to travel, according to UnionPay Co. Mainland visitors bought $3.9 billion worth of insurance products in Hong Kong in the first half of the year, according to the city’s insurance industry regulator, an increase of 116 percent over the same period of 2015.

The regime also continues to crack down on underground banks which facilitate capital outflows. According to reports by mainland paper Financial News, the State Administration of Foreign Exchange (SAFE) seized $8.4 billion in foreign exchange funds during an investigation in late October.

So unlike the mostly state-owned companies which are snapping up foreign assets with the blessing of the regime, Chinese citizens have to find other ways to reduce their exposure to the Chinese economy. They are fed up with the low-interest rates on bank deposits and are increasingly afraid of the risks of the unregulated wealth management products.

(HSBC)

(HSBC)

One channel that still seems to work is the flow of yuan from the mainland to offshore centers like Hong Kong and Singapore. Goldman estimates $45 billion out of the $78 billion in September outflows was transferred from the mainland banking market to the offshore yuan market, where it was likely converted into foreign currency.

The offshore yuan (CNH) has lost 4.8 percent against the Hong Kong Dollar since May where its domestic counterpart (CNY) only lost 4 percent, indicating more selling pressure on the offshore yuan.   

Another vehicle, mostly used when all else fails, is the electronic currency Bitcoin. After moving sideways for most of the summer, the price skyrocketed since late September, coinciding with the latest measures to restrict capital outflows and the drop in the yuan. Alas, it is a bit more volatile than its official counterpart. It’s up 23 percent to $705 since Sept. 25, without regime meddling and for everyone to see.

Read the full article here

A woman counts Chinese yuan bills worth thousands of dollars in Vancouver, Canada, on Oct. 27, 2015. (Benjamin Chasteen/Epoch Times)A woman counts Chinese yuan bills worth thousands of dollars in Vancouver, Canada, on Oct. 27, 2015. (Benjamin Chasteen/Epoch Times)

The chief economist of Citigroup is not your average economist. Yes, Willem Buiter studied plenty of economic theory at Yale and Cambridge but then he says funny things like the New York State Driving Test was his “greatest educational achievement.”

He is also very outspoken for someone who works for one of the biggest banks in the world. He thinks Citigroup “must have decided that it was better to have somebody who tells the truth occasionally than to have somebody who tells what people want to hear.”

Epoch Times spoke to Mr. Buiter about a possible financial crisis in China, a devaluation of the currency and potential solutions. [Skip to 19:00 in the video]

They are going to have a financial crisis.

— Willem Buiter, Citigroup

Epoch Times: What are China’s problems?

Willem Buiter: China has three problems. It has a madly over-leveraged corporate sector, banking sector, and shadow banking sector that really need restructuring and consolidation. It has massive excess capacity in many of the crucial industries, so it has a cyclical problem.

And then it needs to rebalance: From export growth to domestic demand that goes from investment growth to consumption; from physical goods growth to services; from I can’t breathe to green; and a growing role for the private sector. This simply isn’t happening at the moment.

Citigroup Chief Economist Willem Buiter at an interview with Epoch Times in New York on July 6, 2016. (Epoch Times)

Citigroup Chief Economist Willem Buiter at an interview with Epoch Times in New York on July 6, 2016. (Epoch Times)

Growth has stopped falling at the moment, though it is significantly lower than what it was, but only by unsustainable stimulus measures.

This is credit growth that adds to the excessive leverage. Investment in sectors where there is already excess capacity, basically building up a bigger and harder landing by postponing the necessary adjustments.

The rebalancing has been put on hold because this requires active and innovative policy making. With the anti-corruption campaign still in full swing, in its fourth year now and if anything intensifying, all senior civil servants in the ministry or the party are unwilling to stick their necks out and do something untried and new. The stuff that is required both in terms of financial stability management, in terms of stabilization policy, the right kind of fiscal stimulus and in terms of rebalancing.

Epoch Times: What can be done?

Mr. Buiter: We need to increase the role of the private sector to cut back on state-owned enterprises. What is happening? We’re growing state-owned enterprises because that is the path of least resistance because we know how to do that.

So then China is in a holding pattern, and I think it won’t change until there is a long-run rebalancing, until the political issues that are reflected in the anti-corruption campaign are settled, it won’t be supported by the right fiscal policies.

Unless they are willing to go for Chinese helicopter money, fiscal stimulus targeted mainly at consumption not at investment. Yes, some capital expenditure like social housing, affordable housing, yes, even some infrastructure.

But organization supporting infrastructure, not high-speed trains in Tibet. It has to be funded by the central government, the only entity with deep pockets and it has to be monetized by the People Bank of China.

That is what the country needs and at the moment it is incapable politically—not technically—of reaching that kind of resolution. I think it is unlikely that they will be able to achieve that without at least a cyclical downturn of some severity. How deep depends on how quickly they respond when things start visibly going pear shaped.

Workers go about their chores at a construction site for new shops in Beijing on November 28, 2011.  (Goh Chai Hin/AFP/Getty Images)

Workers go about their chores at a construction site for new shops in Beijing on November 28, 2011. (Goh Chai Hin/AFP/Getty Images)

Epoch Times: What’s your estimate of Chinese GDP growth at this moment?

Mr. Buiter: Somewhere below 4 percent. The official figure is still around 7 percent, but those data are made in the statistical kitchen.

Epoch Times: So if growth is 4 percent and interest rates are 8 percent, doesn’t this create problems?

Mr. Buiter: Real interest rates are high in China. Especially for what I call honest, private borrowers. The relationship of the interest rate to the growth rate drives the debt to GDP dynamics. The so-called snowball effect is adverse when the interest rate exceeds the growth rate and that is probably the case now.

So there’s a problem there. They are solvable. That’s nothing beyond the ken of man. The wheel doesn’t have to be reinvented but having the tools and being politically able to use them and willing to use them are different things. China has the tools but not yet the willingness and ability to use them in the way that is necessary to avoid a hard landing.

Financial Crisis

Epoch Times: So we are talking about a somewhat similar problem than in Europe. We would have to write down a lot about of bad debt. We recapitalize the banks and then stimulate the consumer to get inflation?

Mr. Buiter: In Europe of course, we should really fund the capital expenditure. Investment rates are notoriously low in Europe. China has the opposite problem. They need to boost consumption. So there’s an obvious win-win situation that we could have.

Debt restructuring, haircuts if necessary and then a well-targeted fiscal stimulus funded ultimately through the European Central Bank (ECB), people’s helicopter money. China will be aiming at consumption. The composition is different because China invests too much.

You can have a good old financial crisis without having the 1997-1998 Asian foreign debt issue, which China does not have.

— Willem Buiter, Citigroup

Epoch Times: What if China doesn’t address the problem?

Mr. Buiter: They are going to have a financial crisis. It can be handled because 95 percent of the bad debt is yuan-denominated, but you have to be willing to do it, you have to be proactive.

The United States didn’t have a foreign currency denominated debt problem when it had the great financial crisis. Banks fell over. These were all dollar denominated liabilities. You can have a good old financial crisis without having the 1997-1998 Asian foreign debt issue, which China does not have.

So a financial crisis is a risk. Then, of course, a sharp depreciation of the yuan which would be the consequence if the reserves would have to be used to safeguard systematically important entities that do have foreign currency debt. This would be the consequence of a failure to act, a recession and, in the worst case, a financial crisis. Again, something that’s survivable; not the end of the world, but very costly and politically destabilizing.

The official figure is still around 7 percent, but those data are made in the statistical kitchen.

— Willem Buiter, Citigroup

Devaluation

Epoch Times: But the currency would have to go down.

Mr. Buiter: I cannot see the yuan following the dollar over the next year, let alone two years, no. I do think that at the moment, the market is no longer afraid of an eminent sharp depreciation. So capital outflows driven  by expectations of a sharp depreciation have ceased. But they could be back like that, especially if there are more kerfuffles in Europe, another flare up. Maybe the banking crisis, and as a result further upward pressure on the dollar and other safe-haven currencies.

And the Chinese currency is being dragged along? I don’t think so. They will have to decouple. So that is a channel which for external reasons, the yuan peg might become hard to manage.

Epoch Times: How do you see the rest of the year?

Mr. Buiter: Continued subdued growth. China is flirting with the loss of faith in its ability to manage its currency and flirting with a sharp slowdown in activity. Europe and the rest of the industrial world, assuming that the Brexit negotiations remain orderly, not too hostile and growing more slowly than it did last year but not dramatically more slowly.

If Brexit becomes a dog fight between the 27 and the U.K. If Brexit becomes contagious, through general elections in the Netherlands in March next year, in France, Germany. If the Italian referendum in October or November this year goes against the government and fear of emulation of the British example takes over, then there could be a further, deeper slowdown in activity.

The United States again should putter around roughly the same way as last year. So mediocre growth at best with mainly downside risks. A few emerging markets—Russia, Brazil—will do better this year than they did last year simply because it’s impossible to do worse.

The wheel doesn’t have to be reinvented but having the tools and being politically able to use them and willing to use them are different things. 

— Willem Buiter, Citigroup

The specific shocks, home-made mainly in Brazil, partly external like oil prices in Russia and sanctions. These things are no longer slowing them to the same extent. So some recovery is possible.

It’s going to be a secular stagnation world, unless we provide the combined monetary fiscal stimulus and the longer term, supply side, enhancing measures to promote growth, higher capital expenditure, better education and training including vocational training, sensible deregulation, less disincentivizing taxation and all that.

All these things are necessary to keep potential output at a level that allows fulfilling our ambitions, but even the miserable level of the growth rate of potential output won’t be achieved unless we have additional stimulus.

 Epoch Times: So no way for stocks to go up another ten percent from here?

 Mr. Buiter: Everything is possible but I think the fundamentals say no.

Follow Valentin on Twitter: @vxschmid

Read the full article here

A woman counts Chinese yuan bills. (Benjamin Chasteen/Epoch Times)A woman counts Chinese yuan bills. (Benjamin Chasteen/Epoch Times)

He was right about subprime, right about gold, and early in his call for a Japanese crisis. Is Texan investor Kyle Bass too early in his call for a China banking crisis and currency devaluation within the next two years?

“It’s a foregone conclusion but we don’t know about the timing, it feels like it’s happening as we speak,” he told Grant Williams of RealVisionTV in an interview. Bass had first stated his pessimistic view of China in late 2015 when the currency was under pressure and the country was bleeding capital to the tune of $100 billion per month.

Since February of this year and so-called Shanghai Accord or the G20 finance ministers, outflows have abated, although the currency has declined to a multi-year low of 6.66 per U.S. dollar.

There are so many perfect parallels to the U.S. mortgage credit system or the European banking system and the Chinese banking system.

— Kyle Bass, Hayman Capital
The exchange rate of the Chinese yuan versus the U.S. dollar over a year (Bloomberg)

The exchange rate of the Chinese yuan versus the U.S. dollar over a year (Bloomberg)

So why does Bass think the situation in China is intensifying? Everybody knows China has too much debt, especially corporate debt. As a result, the country’s total debt to GDP ratio is higher than 250 percent according to a range of different estimates. This is not much higher than Japan’s government debt ratio of 245 percent of GDP, so why focus on China now?

“The Chinese corporate bond market is freezing up. Since April 11th the Chinese corporate bond markets had 150 cancellations out of 210 announced deals,” says Bass. And indeed, the Chinese corporate bond market, which has helped keep unsustainable corporate debt afloat and also backs trillions in repackaged loans called Wealth Management Products (WMP) is in trouble in 2016.

Source: McKinsey

Source: McKinsey

According to Bloomberg, Chinese companies raised 1.85 trillion yuan ($280 billion) of onshore bonds between April and July this year, 30 percent less compared to the three preceding months.

Bankruptcies are also on the rise. Although corporate defaults are still in the low double digits, Chinese courts handled 1028 bankruptcy cases in the first quarter of 2016, up 52.5 percent compared to a year earlier.

“There are so many perfect parallels to the U.S. mortgage credit system or the European banking system and the Chinese banking system. There are things that go on in those systems that show you there are problems,” says Bass, emphasizing the acuteness of these problems. “We see it starting now.”

While there are clear parallels to what happened in the United States in 2008 and Europe in 2010, Bass says that China’s problems are a magnitude larger. “They have asset liability mismatches in wealth management products that are more than 10 percent of their system. Our mismatches were 2.5 percent of the system and you know what they did,” he says. 

According to Bass, the bad loans will first hit the banking system and then lead to a sharp devaluation of the Chinese yuan. 

“How they deal with this, it’s not armageddon. They are going to recap the banks, the are going to expand the People’s Bank of China’s (PBOC)  balance sheet, they are going to slash the reserve requirement, they are going to drop their deposit rate to zero, they are going tot do everything the United States did in our crisis,” he said.

Devaluation

All of these policy measures would lead to a depreciating currency all other things being equal. But China’s currency is already under pressure as mostly Chinese citizens are taking their money out of the country because they don’t trust the banking system any longer. Bass estimates that bad loans could lead to losses of up to $3 trillion or 30 percent of GDP. Chinese citizens’ savings are backing these loans and they don’t want to wait around to find out whether Bass’s number is correct or not.  “In China, the credit excesses are already built in,” says Bass. 

They are going to do what’s best for China. And what’s best for China is to materially devalue their currency.

— Kyle Bass, Hayman Capital

Goldman Sachs estimated that net capital outflows from China in the first quarter of 2016 were around $123 billion according to a report, 70 percent of which came from Chinese citizens funneling money out of the country. They do this in spite of harsher capital controls in 2016 and use either illicit methods like smuggling or legal ones like buying up Vancouver and New York real estate.

According to Bass, there is no way out for the regime, which is trying to manage the devaluation as much as it can. “The Chinese government wants a devaluation, they just want it on their terms.”

Reuters had previously reported that the Chinese central bank would not mind seeing the currency slip to 6.80 against the dollar, a target it will likely overshoot if things don’t change materially.  

Bass also shines light on why the regime would not be opposed to devaluing the currency, albeit measuredly. He says one of president Xi Jinping’s closest aides, vice premier Wang Yang, thinks the Japanese made a mistake by not devaluing in the mid-1980s, right when they were blowing up their own credit bubble. 

“Wang has said that he thinks Japan’s critical error was agreeing to the Plaza Accord. Japan decided to be submissive to the United States once again, to sacrifice their economic growth for that of the United States,” as the dollar devalued and the Japanese yen strengthened, the United States finally emerged out of a decade of stagflation. what happened to Japan at the beginning of the 1990s was less flattering. According to Bass, however, this time will be different: “They are going to do what’s best for China. And what’s best for China is to materially devalue their currency.”

After the devaluation and the recapitalization of the banking system, however, it’s time to buy again: “If you have any money left, it will be the best time in the world to invest. It will be the greatest time ever to invest in Asia.”

Read the full article here

After the market fireworks at the beginning of the year, things started to quiet down at the end of February right after the G20 meeting in China. This quiet is about to end if we take the Chinese currency as an indicator.
Markets were worried the yuan would crash against the dollar with some hedge fund managers even betting on a 50 percent decline in 2016. China’s stock market crashed some 25 percent in January and the S&P 500 lost almost 10 percent at its low point in February.
After the unofficial Shanghai Accords—named after the place of the G20 meeting—this concern receded as the U.S. dollar weakened and emerging market currencies including China’s yuan appreciated. The Federal Reserve played a part as it skipped raising interest rates during its first meetings in 2016 and Chinese capital outflows markedly slowed from March onwards.
So the yuan hit a relative high against the dollar in March at 6.45, the S&P 500 made it to green for the year, but it seems this was as good as it gets.
For no apparent reason, the yuan then started to decline and is approaching the January lows of 6.60 per dollar.

At the beginning of May, Australia defected from the rest of the world’s central banks by cutting interest rates in an effort to weaken its currency, breaching the agreement to let the dollar weaken across the board.
On May 18, the Federal Reserve released the minutes of its March meeting, indicating it may just raise rates again. This led to a sharp sell-off in the Chinese currency and prompted the People’s Bank of China (PBOC) to intervene in the currency markets to strengthen the yuan.
The Chinese economy and possible capital outflows are coming to the forefront of analysts and traders again.
Read MoreChina Expert Evan Lorenz Says Yuan Devaluation Will Happen
“China’s macro [economic picture] may weaken (against the recent consensus of a cyclical upturn) and there is a risk that capital outflows will pick up again,” the investment bank Nomura writes in a note to clients.
Ever since the Fed started to tighten global liquidity at the end of 2013, the U.S. dollar has steadily crept higher, conversely pulling the yuan lower. Since 2015, the falling Chinese currency has preceded market turmoil in the fall of last year and at the beginning of this year.  
Now all eyes are on the Fed which meets on June 16-17 and is highly likely to raise rates, at least according to best-selling author James Rickards:
“I think in June, particularly after having skipped March, they’re going to want to get back on track. They’re going to raise rates, but the market expectation is still not better than 50 percent that they will,” he said right when the dollar put in a bottom in March.  

Read the full article here

China is probably looking forward to the new year. A fresh start on Feb. 8, putting all the currency chaos behind.
This may well remain wishful thinking, as events are going from bad to worse—and Jan. 6 is no exception.
The Chinese yuan fell 0.6 percent—this is a lot for a big currency—to 6.55, the lowest level since March 2011. Traders dumped the yuan after China’s central bank fixed its value 0.22 percent lower, another official devaluation.
China first devalued the yuan in August of 2015 and then intervened with great force in the market to keep its value relatively stable, spending $255 billion of its foreign currency reserves by the end of November.
China’s foreign exchange reserves as of Nov. 30, 2015. (Bloomberg)
After the International Monetary Fund included China in its basket of reserve currencies in November as well, Beijing reduced the reserve burn and let the currency drift down gradually.
Beijing also gave the market a fair warning, as it said it would index the value of the yuan against a basket of currencies, not just the U.S. dollar.
The yuan’s value in U.S. dollars dropped in 2015, but it rose against the trade-weighted basket. This gives Beijing justification to further devalue against the dollar.
(Capital Economics)
“China is going to have to dramatically devalue its currency,” Kyle Bass, principal at Hayman Capital Management LLC., told Wall Street Week. He thinks the devaluation could be as much as 20 percent.

So investors took heed and are getting out of the yuan as fast as they can. After all, why stick around to lose money in a falling currency. The problem: This herd behavior leads to, you guess it, a falling yuan. 
And while Chinese regulators can stop them from wantonly selling the mainland currency (CNY) because of capital controls, nobody is stopping them from selling the freely traded offshore yuan (CNH), mostly traded in Hong Kong
READ about China’s two different currencies here
The CNH dropped 1.1 percent against the dollar, trading as low as 6.70, the lowest since September 2010. The spread between the mainland and the offshore currency also widened to a record 2.5 percent.
(Bloomberg)
Capital Outflows
Behind the move in the currencies is the tectonic shift in capital flows. Up until 2014, China attracted capital, driving the exchange up. Now capital is moving out, driving the exchange rate down.
“You’ve gone from a period which you had this one-way bet—the currency was going to appreciate, capital inflows—to the reverse. Having a period in which your own residents want to diversify into something else,” says Harvard professor Carmen Reinhart.
She thinks China is facing “a significant internal debt crisis,” which is why domestic citizens and international investors are moving their money out.
READ Carmen Reinhart on China’s Debt Crisis
“You do have a shift in capital flows and in fact, that shift has also accelerated purchases of real estate in London, in Boston, in New York. You see that it’s not just Treasurys. We see that from China and we see that from Russia,” she says.
Bloomberg estimates as much as $367 billion of capital left China in last three months of 2015. Epoch Times previously estimated capital outflows of $850 billion in the first nine months of 2015, so the total could be more than $1.2 trillion, the same as Societe Generale’s worst case estimate. 
China’s big trade surplus is the reason it didn’t have to sell more foreign exchange reserves to keep the currency from collapsing. 
Why Devalue
There is nothing China can do against the capital flows per se, expect for completely reforming its economy.
It can intervene in the markets by selling its foreign currency reserves to stop the exchange rate from collapsing. For the onshore yuan, it can also enforce capital controls more strictly, which it has done, but that goes against the promised reforms. 
However, given only bad choices, managing a gradual devaluation in the offshore and onshore yuan is actually the best of the worst.
Past currency crises, like the British pound devaluation in 1992, the Asian financial crisis in 1997, and the recent Ruble crash, show the value of the currencies will always drop to its equilibrium level—no matter how much a country spends intervening in the market.

So if the currency has to drop, China can at least keep its large stash of foreign currency reserves, although cynics may then ask what good are they for after all. 
“The foreign exchange reserves are just that: they are foreign. They are not renminbi [RMB]; they are not money that can be brought to bear domestically,” says Fraser Howie, author of “Red Capitalism.”
A lower currency on the other hand will support the country’s export sector, which, thanks to rising land and labor costs, is not as competitive as it used to be. Kyle Bass thinks a devaluation will help China “come back to some level of competitiveness with the rest of the world.”
It needs to compete not to generate growth, as many think. Although the Beijing Academy of Sciences just estimated GDP will only grow 6.7 percent in 2016 (below the official target of 7 percent)—it is employment and public sentiment that matters most to the regime.
The export sector still contributes around 10 percent to total employment.
Gordon Chang, author of “The Coming Collapse of China” says: “Where you have people just sick and fed up, especially when the system is no longer delivering prosperity. When you have real serious economic problems, I think people are going to say, ‘I’ve had enough.’”
Until then, the yuan has a lot further to drop.

Read the full article here

To its credit, China actually implemented a couple reforms this year. Does this mean, it will let markets rule? Most likely not. Because when push comes to shove, China will stop reform and subdue market forces.
Case in point: The central bank and regulators now micromanage the foreign exchange market and have suspended at least three foreign banks from foreign exchange trading until March 2016, according to Reuters.
They also asked banks to disclose names of clients with the intent of stopping state owned enterprises from buying foreign currency.
“They are worried about falling foreign exchange reserves. The yuan faces obvious depreciation pressure as the Fed (U.S. Federal Reserve) may continue to raise interest rates, so policymakers are concerned and intend to take effective measures to respond,” a senior economist at a think-tank linked to China’s Cabinet told Reuters.
(Twitter)
Massive capital outflows have pushed the onshore and the offshore yuan down to levels not seen since 2011. Some people in China’s regime might welcome this move, as it could boost exports and prevent mass unemployment.
“Capital flows depends on China’s economic fundamentals; we shouldn’t worry too much about short-term capital outflows if we are confident about our economic fundamentals. The direction of capital account reforms will not change,” a government policy advisor told Reuters.
Some others want to micromanage it, fearing outflows may spiral out of control and hurt the country’s economist stability. Because of the economic law of the impossible trinity, China can’t have a stable currency, independent monetary policy, and a free capital account at the same time.
For now, it seems policy makers sacrifice the free capital account—originally on the reform agenda—for a stable exchange rate.
MORE:Was 2015 a Historic Turning Point for the Chinese Economy?
In November, “Red Capitalism” author Fraser Howie said China hasn’t really been tested with regards to letting market forces play out in the foreign exchange market.
“You don’t simply have a free trading currency just because you say so. How is China going to respond in times of crisis?”
Judging from the reaction of Chinese authorities to the continued drop of the yuan, we now have a crisis and we also now know how the authorities respond.    

Read the full article here

The only thing China had to wait for was the official inclusion into the International Monetary Fund’s (IMF) reserve currency basket.
Now it can devalue its currency as it pleases—and it may not even have a choice.
“A devaluation could be as much as 20 percent against the U.S. dollar because in real effective exchange rate terms the yuan is about 15 percent overvalued at the moment,” says Diana Choyleva, chief economist at Lombard Street Research.
The Chinese currency has gained 15 percent against other major currencies since the middle of last year, according to an analysis by Westpac Strategy Group.
On cue, China set the yuan at 6.414 to the U.S. dollar Wednesday, its weakest level since August 2011 and down 3.4 percent since the mini-devaluation in August.
(Bloomberg)
Choyleva thinks the IMF inclusion may have even prevented a sharper one-off devaluation. “They would not be so keen to be a responsible citizen,” she says and expects further gradual devaluation.
Macquarie analysts also believe Beijing now likely won’t “risk their credibility by devaluing the yuan sharply after that.”
But while there is clarity as to how (gradual) and how much (15-20 percent) China will devalue, there is still confusion as to why they have to do it.
Market observers usually cite exports as the major reason for a cheaper currency. In theory, prices for Chinese goods would become cheaper on international markets so volumes would pick up.
In practice, this rarely works, as imports become more expensive, as China is a big importer too.
In addition, trade just doesn’t contribute that much to the Chinese economy anymore.
“They were at the peak which was just a few years ago. Their net exports were 8 percent of GDP. Now it’s just a couple of percent of GDP,” says Richard Vague, author of “The Next Economic Disaster.”
Exports make up even less of GDP growth, barely visible on the chart below. Consumption and investment make up most of Chinese GDP growth.
(Macquarie)
To fire up consumption and not let investment drop of a cliff, China has lowered interest rates 6 times this year.
“You have had six interest rate cuts in the past year. And yet the economy is meant to do fine at 7 percent or so. And that doesn’t tally with the reality on ground—the economy is growing much slower,” says Fraser Howie, author of “Red Capitalism.”
It’s the combination of low growth and easy money which puts pressure on the currency. Because the regime created a debt bubble of epic proportions and investors now realize they won’t get the promised returns, capital is flowing out of the country at a record pace.
Until the imbalances are fixed and China takes its losses, and stops the easy money policies, outflows will continue and the regime will face continued pressure to devalue.

So far, the regime has managed the decline by selling foreign exchange reserves. Purely from an economic point of view and disregarding the IMF power politics, it would be better do correct the imbalances with a one off devaluation.
History teaches us that countries spend foreign exchange reserves to defend their currencies and most have to devalue in spite of it. The Russian ruble is a good example from the recent past, the Asia currencies and the British pound are good ones from the 1990s.
So if you can’t have your cake and eat it too, why not just keep it?

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A clerk counts stacks of Chinese yuan at a bank on July 22, 2005 in Beijing, China. (China Photos/Getty Images)A clerk counts stacks of Chinese yuan at a bank on July 22, 2005 in Beijing, China. (China Photos/Getty Images)

China has been the world’s second largest economy for some time, ahead of Japan. Now it has also managed to overtake the yen as the No. 4 currency used in global payments, according to banking systems provider SWIFT. 

This has brought back the crowd of people claiming that the yuan would one day become the world’s reserve currency. 

“This is the mooted decline of the U.S. dollar’s premier reserve status as the yuan becomes a reserve currency, which is one that is widely held by governments and institutions among their foreign-exchange reserves because it is seen as a store of value,” Fidelity’s Michael Collins wrote in June 2014.

Let’s take a step back to see if overtaking the yen makes much of a difference. 

To put things in perspective, we can see that the yuan is now ahead of the yen by a mere 0.03 percent—at a grand total of 2.79 percent of all payments on the SWIFT system compared to the yen at 2.76.  

How SWIFT can call this a “stellar ascension” is unclear. To be fair, the yuan’s use gained 1.4 percent to almost double. What most people fail to mention is that the dollar added 6.07 percentage points to 44.82 percent of all global payments.

Global use of different currencies. The dollar is still on top. (SWIFT)

Global use of different currencies. The dollar is still on top. (SWIFT)

The British pound and the euro are far ahead of the yuan as well, and this situation won’t change much until China completely liberalizes its capital account and reforms its financial system.

Until then, China may have a financial crisis to deal with, which could further dampen the use of the currency to be commensurate with the size of its economy and its status as the world’s largest trading nation.  

Regardless, there are other criteria that the yuan needs to fulfill to become a reserve currency, and it’s far away from checking those boxes too. 

“To be a reserve currency means that countries that have reserves have to invest it in something, so you need a deep liquid pool of investable assets. China does not have that. There is no Chinese bond market … and it would take 10 to 15 years to develop one,” says Jim Rickards, author of “Currency Wars” and “The Death of Money.” 

Even the IMF poured cold water over China’s ambition to become part of its reserve currency, the Special Drawing Rights system (SDR), when it delayed a possible inclusion until September 2016, rather than January, as is customary.  

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