China Devaluation Thoughts of the Day

Every time you think the Chinese economic and financial situation is starting to stabilize, Beijing goes and upends everything.  The good news is that regular readers will be familiar with these issues and will be somewhat prepared. The 2% devaluation by the PBOC today has sent shock waves through the Chinese markets today.  I believe there are a number of implications of this move.

  1. Despite all the cheery talk in the press release about market orientation this move reeks of desperation to jump start and export market falling faster than a Party official jumping to his death. This reveals profound concern about the state of the economy.
  2. While the PBOC is trying to sell this as a model based readjustment to better align with market prices, the reality is it is opening itself up for further devaluation pressures. There is nothing worse than a central bank that has no credibility.  Want evidence the PBOC is losing credibility?  The trading rate was already near the new official rate almost 2% away from the old official rate prior to the devaluation.  That means the market was already moving outside the band.  If the PBOC loses the financial markets, this will get ugly fast.
  3. The biggest currency risk here is that be resetting expectations on the RMB/$, it is creating future expectations of devaluations. The PBOC can talk all day about market conditions and their models, but markets don’t like to be surprised and the PBOC has just created future expectations.  It will be very hard for the PBOC to put this genie back in the bottle.  The real risk is that China is going to be forced to release the RMB.
  4. This is going to hit a lot of companies hard such a real estate developers and LGFV foreign currency bonds. While the general perception is true that overseas borrowing is not a large part of China’s credit, certain sectors are heavily exposed and you can expect those bonds which are already in high risk sectors with little onshore legal recourse, to see real hits.
  5. China might be giving up on its SDR aspirations with this move. It should come as no surprise that it was only late last week the IMF released its report noting their concerns about RMB inclusion in the SDR.
  6. It should come as no surprise that this is announced a day after awful trade data. Don’t think the two aren’t related.
  7. If China is trying to attract foreign capital to buy into its stock market, LGFV bonds, or propping up its banks, this isn’t the way to do it. The 2% devaluation is unlikely to have any impact on export volumes and definitely not in the near term.  The real problem here is that it will make it more difficult to attract long term investment capital.
  8. The plunge in emerging market currencies will come under only greater pressure placing enormous downward pressure on prices throughout emerging and developed markets. Think of this as a true beggar thy neighbor competitive devaluation.
  9. The real storm will come when the Fed raises rates sucking capital out of China and other emerging markets. In other words, the real turbulence is yet to come.  The market is unlikely to be satisfied with 2% and the PBOC just reduced its credibility by surprising the market.
  10. Remember: the stock market is the side show. Credit and currency are the real trigger points. There is absolutely a lot more weakness and building pressure on all these markets.

4 thoughts on “China Devaluation Thoughts of the Day

  1. Pingback: Six thoughts about the Yuan devaluation | Homines Economici

  2. Pardon my ignorance, but what “trading rate” are you referring to? Is there some (onshore/offshore?) RMB “grey” market? If so, is it legal and why couldn’t it be arbitraged?

    • There are actually three rates up for discussion. First, the official PBOC rate around which it allowed a +-2% fluctuation. The PBOC would announce every morning what the official rate was. In recent history however, they have intervened heavily in the market to keep the permitted fluctuation much lower in reality. Second, in recent days the actual rate at which trades were being made were on the lower outer edge of that band. It hadn’t really breached the +-2% band, but it was bumping against it. Think of this rate as the actual rate at which trades were taking place. Third, the offshore rate is uncontrolled by the PBOC and can trade at whatever the market bears. OVer the past week or two that rate has increasingly diverged by not enormous amount but not insignificant. The offshore rate in places like Hong Kong and Singapore is different by about 1/2% from the onshore rate. Due to capital restrictions, it would be exceedingly difficult to arbitrage the two rates.

  3. Pingback: More noise on the Yuan | The Gold Standard

Comments are closed.