China FX Reserve Depletion Accelerating: Yuan Devaluation To Follow Suit
Circuit breakers, suspending circuit breakers, accelerated devaluation of the yuan, followed by intervention to slow the devaluation, record foreign exchange reserve depletion, PMI contraction and more panic: Just Another Day in China. (JADIC) In this blog, China watching has been a major focus for quite a while, particularly with regards to devaluation and its effects. You can read about this here, here, here, here & here. The steps and missteps of Chinese monetary policy have roiled global markets and have impacted the price of bitcoin.
The chart below shows that China's FX reserves fell for the first time since 1992, but more worrying is the accelerated pace with which they are falling. December saw the biggest monthly drop on record. This has been the result of keeping a tight yuan peg with the US dollar and capital outflows. Quite simply, it has become too expensive for China to keep a tight peg versus USD because of the dollar strength. Hence they have been loosening the peg as a form of monetary stimulus. The other problem has been capital outflows. Despite all the efforts to keep money on the mainland it has not worked. What does this mean? China has lost control of capital outflows. The policies employed thus far have been ineffective. As the economy and the currency continue to weaken and the Shanghai implodes, more and more money is moving offshore.
China has continued to focus on RMB depreciation has has continued fixing the value (mostly loosening) almost daily now. According to the Financial Times, "the size of FX liabilities that still needs to be unwound is around $300 billion according to our estimate (not including importers USD buying and domestic portfolio diversification) RMB depreciation will continue." It does not include those moving money offshore.
The Yuan Continues to be Overvalued
The yuan continues to be overvalued. The the current price of USDCNH (6.69) and estimates that the yuan is ~30% overvalued, a few scenarios have been run below as to what the prices would be if it climbed:
- 10% = 7.35
- 15% = 7.69
- 20% = 8.02
- 30% = 8.69
As one can see, there is still a ways to go regardless of where it goes. The other problem is the chances of an orderly devaluation seem unlikely. As the market begins to sniff how much of a devaluation the PBOC want to go, their hand might be forced by market forces like what happened back in August when they announced a 2% loosening and sheer panic ensued causing it to spike even further. If Mr. Market gets spooked beware. Something else to watch for is the velocity of the devaluation. This could cause major shockwaves throughout global capital markets and something the PBOC could lose control of quickly especially if FX reserves continue depleting. At some point China may be forced into full blown QE instead of all these side moves which aren't getting the response China wants. That would accomplish 2 things: instant devaluation of yuan and the kind of bazooka monetary easing maybe China needs to stop the bleeding and pacify the international investment community.