The Chinese Yuan Is Collapsing

Tyler Durden's picture

The Yuan has weakened over 250 pips in early China trading. Trading at almost 6.22, we are now deeply into the significant-loss-realizing region of the world's carry-traders and Chinese over-hedgers. Morgan Stanley estimates a minimum $4.8bn loss for each 100 pip move. However, the bigger picture is considerably worse as the vicious circle of desperate liquidity needs are starting to gang up on Hong Kong real estate and commodity prices. For those who see the silver lining in this and construe all this as a reason to buy more developed world stocks on the premise that the money flooding out of China (et al.) will be parked in the S&P are overlooking the fact that the purchase price of these now-unwanted positions was most likely borrowed, meaning that their liquidation will also extinguish the associated credit, not re-allocate it.


While widening the trading bands keeps some semblance of rationality, this is anything but an orderly unwind of the world's largest carry trades:

For some context, this is the biggest quarterly drop in CNY since Q4 1993...



How Much Is at Stake?
In their previous note, MS estimated that US$350 billion of TRF have been sold since the beginning of 2013. When we dig deeper, we think it is reasonable to assume that most of what was sold in 2013 has been knocked out (at the lower knock-outs), given the price action seen in 2013.

Given that, and given what business we’ve done in 2014 calendar year to date, we think a reasonable estimate is that US$150 billion of product remains.


Taking that as a base case, we can then estimate the size of potential losses to holders of these products if USD/CNH keeps trading higher.


In round numbers, we estimate that for every 0.1 move in USD/CNH above the average EKI (which we have assumed here is 6.20), corporates will lose US$200 million a month. The real pain comes if USD/CNH stays above this level, as these losses will accrue every month until the contract expires. Given contracts are 24 months in tenor, this implies around US$4.8 billion in total losses for every 0.1 above the average EKI.


Below we have tried to simplify what is happening as much as possible... (since there are many pathways into and out of all of these positions) to try and enable most to comprehend the problem

Virtuous circle... (last few years)

  • Specs sell USD/JPY/EUR, Buy CNY
  • Use CNY to buy copper/commodities
  • Use copper to finance credit
  • Use credit to finance working capital/real estate purchases
  • Real estate goes up, more credit available
  • Copper goes up, more credit available
  • encourages more buying CNY to start virtuous circle...

BUT what happens when one of these chains start to break? OR ALL OF THEM? (now!)

  • Thanks to PBOC, can't roll debt via shadow banking system
  • Can't rely on local govt to bail out cashflow
  • Sell copper/commodities to meet cashflow needs
  • Copper price goes down, credit tightens
  • Credit tightens, Real estate prices drop
  • Real estate prices drop, specs start exiting CNY
  • CNY weakens...

And then... (tomorrow)

  • Plenty more firms piled on to use the inexorable trend in CNY strengthening as their carry-trade piggy bank (or merely to hedge their export receipts)...
  • Those derivative (over-hedges) are now losing money very rapidly...
  • Liquidate hedges - downward pressure on CNY
  • downward pressure on CNY, more losses...

Remember carry-traders are little more than sophisticated leveraged momentum players - so when the trend is no longer your friend, no amount of carry-arbitrage will cover MtM losses on the notional...


Arguing that the PBOC can defend the currency is moot (they clearly do not wish to); Arguing that the PBOC will manage liquidity via their huge FX reserves is moot (they have done so with the banks - who are awash with liquidity as noted by the low repo rates) - this is about forcing the shadow-banking system to shrink before the bubble becomes totally untenable... unfortunately, we suspect it already has...

Oh dear, remember the Chinese corporation that untenably insolvent but "promised" it would meet interest payments in July and not default... well:


Uh oh...

All the carry-funded idiocy of the world is starting to uwind


As the world slowly realizes the Fed's growing hawkishness (what are they afraid of? or do they really believe that the economy is growing organically?)

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LetThemEatRand's picture

Granted it's still priced at levels from a year ago, but a pretty big move in a short time.  There is a currency war afoot.  I'm guessing boots on the ground somewhere if this continues.

Johnny Cocknballs's picture

I'm guessing China offers a gold-backed currency and/or dumps us treasuries if they feel their currency is being attacked, in a way which goes beyond irritating into harmful. 

But, I wouldn't read all that much into this one yet. jmo.

fonzannoon's picture

Johnny I like your stuff, I really do. But this article is the complete opposite scenario from a gold back currency. This is Tyler telling gold bugs to bend over and hold your ankles. 

kliguy38's picture

Hmmmmmmm.........simple..........SELL THOSE FOCHIN TREASURIES..........

fnord88's picture

i think China will offer to swap their treasuires for Gold at $20 000 an ounce.

DoChenRollingBearing's picture

China might go for that.  I (as US President) probably would not.  I would hold out for $55,000...

0b1knob's picture

How does an American make an easy buck on this trend?

zaphod's picture

Correction, ALL currencies are crashing.

It is going to get ugly before this is over.

National Blessing's picture

The American Dollar is king.  And it will remain king.  No kidding.  You guys just don't get it.  The game is rigged.  Silly bastards.


The dollar sure is king. Doesnt matter if yuan/yen/whatever falls, its when EVERY other currency throws in the towel and the dollar goes to the moon the end is imminent. Until then, hold tight.

new game's picture

what we have going on in agregate 3.5 x debt to gdp-not sustainable as approaches that minsky moment,

what will trigger the flash crash? china first? euro, japan, austrailia, untiedusa? world growth sub 2.

flight gone missing or was that to security?

StychoKiller's picture

Just another trickee day (for you, round-eye!)

The Shootist's picture

Sink the US and rise like a pheonix.

SilverRhino's picture

It's that damn missing Malaysian Boeing 777's fault !!! 

old naughty's picture

Of course it is.

Now run.

Ooopse, no planet for (good?) old hu-mans.

SilverRhino's picture

It's that damn missing Malaysian Boeing 777's fault !!! 

furgheddubouddit's picture

I'd love to see USD/CNY spike to 7 just to clear out the stupid morons who keep placing these overleveraged one-way bets, and cause the entire financial system to skew and disconnect from economic reality in the process.

The sooner these 'no way we can lose' one way bets are eliminated, the sooner we can get back to allocating financial resources sensibly and efficiently, and perhaps experience some real organic economic growth again instead of the charade of smoke and mirrors we have now.

kaiserhoff's picture

this is anything but an orderly unwind of the world's largest carry trades:

Looks pretty orderly to me, as in an order to abandon ship!

Tomorrow's weather forecast: Skydiving banksters, sans parachutes. 

NoDebt's picture

Looking for signs of contagion.  This one has the possibility.  It's big enough and it directly affects banks (which are all interconnected, worldwide).  

You're really just betting on when the PBOC decides "enough's enough" and turns the spigot back on.  Absent that contingency, yes, this would spiral down to catastrophe.  But they CAN turn the spigon back on and eventually they WILL if things get bad enough.  How soon and how bad before doing so are the only things in play.

fonzannoon's picture

"You're really just betting on when the PBOC decides "enough's enough" and turns the spigot back on."


kaiserhoff's picture

Yes, but.

If they print on a scale to cover the fraud, that still does nothing to diminish the fraud, or the need to print more to cover the new fraud.  Currency goes Zimbabwe, which I think it will, and there goes all trade with China in the ensuing chaos.

Got popcorn?

markar's picture

Right. That's why China has been snapping up every available oz. they can get their hands on. 

ThroxxOfVron's picture

"This is Tyler telling gold bugs to bend over and hold your ankles. "

Martin Armstrong has also been telegraphing a rather pessemistic view of Gold.


Margin calls mean liquidations.   Real estate, and to a great extent bonds/debt and equities, are far less liquid than Gold.

It's pretty simple: weak hands are going to be forced to hand over their Gold once the margin calls accelerate.

China bought a fuck load of Gold over the last few years; so now the trend is reversing and Gold is probably going to be sold hard into carry/leverage unwind.   It might not bottom for a year or more based just on China burning off froth.

zhandax's picture

China is not the one that needs liquidity.  It is the speculators.  Who holds most of the gold now?  Of the Chinese speculators, where do you think any gold handed over to settle margin will end up?  Any non-Chinese players who are captured in the margin trap will have to hand over what?  T-bills?  This doesn't change the country who holds the gold a bit.

Squid-puppets a-go-go's picture

exactly. any phyz gold sold by chinese companies will be bought by the PBOC

in other words, a big sell off will hasten the day that china can flip the switch and provide a global gold backed currency

Johnny Cocknballs's picture

thanks; I know, I read this after reading similar at wsj and before reading similar or related at reuters and elsewhere. 

I think a gold backed currency may be in the works, but is longer term.  I think selling treasuries is likely,just as people getting out of long positions was likely in response to the recent PBOC moves, which were designed, in the longer term, to make the currency less susceptible to speculation, and |: collateral attack.

But I think the Chinese have a few more tricks up their sleeve.  I think they will get rid of some built up inventory.  I think they will peg to a basket, maybe, and I think for sure they'll be making more deals with Rusia in Siberia and maybe JVs in Kazakhstan, and if they're smart, JVs with Russia in Africa. 

I don't know or care what paper gold will do - the pricing means nothing, as I think most of ZH agree.

The trend has been obvious. I'm suggesting that Chinese fundamentals, tools, and options are better than is commonly supposed, and you will see exports tick up, more mid and long term investors coming on board, and quite possibly some sort of change to how the Yuan is pegged and/or backed.  I'd not be surprised if it declines further, maybe considerably, in the coming days, even eweeks.  But I'd be more suprised if this wasn't strongly reversed after say 5/6 weeks and beyond.

Certainly don't claim to be an expert let alone omniscient. But on this one I feel pretty sure that rumours of the Yuan's collapse have been exaggerated. 

We'll see, as always. PArt of this depends on whether you think the yuan is fairly or undervalued right now.

I think much also depends on whether or not you think the Chinese think they are more or less likely to get back their investment on US debt as time passes, and whether or not you think pressure on their currency or gdp makes them more or less inclined to buy/sell. 


chindit13's picture

fonz, besides that, I have no idea what a "gold-backed currency" means in terms of China.  First, who believes anything China says now, and why would anyone believe anything they said about any "backing"?  Next, does anybody really believe China would go to all the trouble of loading up on gold, then allow anybody---especially foreigners---to exchange yuan for that gold?  Third, what is the size of China's economy relative to the market value of its gold holdings--it's not like China can just say each of their ounces is worth a million dollars, and then claim their delusional value backs their currency.  Finally, if the best gold's popularity gets after all the printing worldwide since 2009 is $1330 an ounce, why would everyone suddenly stand up and take notice that China backed its currency with something that isn't exactly lighting the investment world on fire?

As for the oft-noted "dumping of USTs", the only reason anyone gives that a moment's thought is because of China's long history of being its own worst enemy.  Right now, odd as it seems, the yuan is backed by those same USTs, since yuan creation is to some extent a result of the PBoC taking in exporters' FX revenues (note:  REVENUES, not profits, since ongoing businesses are China's loss leaders while any profits have come from domestic RE speculation) in exchange for freshly printed yuan.  Anyway, I'm a penny bid for the whole lot (by CUSIP number).

In years hence, look for the term "Chinese Economic Miracle" on the same page as Potemkin Village.  As a nation, they peaked in 2500 BC, went semi-fallow until about 1300, then sat out the Age of Enlightenment and the Renaissance until others did the heavy lifting and they could buy (or steal) off the shelf.  Inventing the lightbulb might be called a miracle, but buying one at Home Depot is just called commerce.  The Chinese body twitched around 1990, trying to pull a Lazarus, but the coroner might be just about to tell the insurers that they can cash out the policy and let China join other once high flyers such as Egypt and Portugal as nations that used to be somebody.

Johnny Cocknballs's picture

I don't think they'd necessarily back the yuan with gold. I'd think they'd back a currency with gold and/or peg the yuan to a basket of currencies.  I don't think they've been acquiring gold just to hoard it - why do you?


Your analysis is cute but for the fact China has manufacturing and trade surpluses which the US does not - it has the petrodollar/bretton woods system that is backed up by a military which is over-extended, and a huge portion of GDP - misallocation and graft [f-35] is up against cheaper tech designed to "moneyball" defense against these very systems.

It's one thing to be pessimistic, it's quite another to justify it with absurd, hyperbolic, and non-relativistic assessments which dismiss not only an ancient culture, but the success of countries which steal, copy and reverse engineer - to include Taiwan, Israel, and South Korea. 

The dollar isn't going to crash overnight or lose most of its value anytime soon, but it is clearly trending down, while the economy behind the FRN continues to export jobs, import unskilled immigrants, and squeeze the middle class from every direction while saddling them and their grandchildren's grandchildren with debt - much of it owed to China.

Not having enough buyers for your product is a problem.

Not being able to make a product is a bigger one - no matter what happens in the short term as the result of market specs.

hobopants's picture


In a situation of de facto jubilee the score board goes to zero but you still get to keep your chips... commodities, capital equipment and infastructure are a big plus. The trillion dollar question is how will those chips fall? Do we sell that big ole military to pay our bills? or do we use it to maintain our place of parasitic privilege? Or to put it another way do things fall apart into chaos or does the current regime grip tighter and unleash fresh hell upon the globe a' la Iraq times a million.

It's odd that the rest of the world really isn't the problem. It's the spoiled mentally retarded country with the ridiculously big stick.


zhandax's picture

To simplify this reductio ad absurdum, as an investor, would you rather hold a currency whose government sits on the largest stack of gold on the planet, or a currency that claims to sit on the largest pile of gold on the planet, but the government has prevented audit for 60 years?  I think it is around June when the former is released, while the latter is documented.  For anyone looking for the sneak preview of the conclusion, of course.  The bounces and jiggles on the way there reminds me of happy hour at the Cheetah III.

Apostate2's picture

I do not think @Chindit's analysis is 'cute' at all. Your take that China will back its currency with gold and/or a basket of currencies is also a WSJ/Reuters take based on the fact that China has signalled this over the past decade (when they decided to let others know about it).

The main sticking point is how to get/ascertain the vital data to understand and verify the true state of their economy. So far this has been reckoned by using a variety of second party data-- a case in point is import/ export data, the suppies of copper/metals, energy imports/ and so on ( that's why the HSBC data is tracked with the China data). None is ideal.

Why? Simply put: it is unreliable and a holdover from the pre-reform period. Goodness knows they tried to rectify their statistical and accounting procedures to map international standards but a command economy mentality (re: standards and quotas set by the central planners) is a tough ideological nut to crack. And, the SOEs are still a driving (and favoured) force in the economy and that is where the recent problems lie. 

Let me expaciate a bit more. There are two fairly distinguishable ideological divides in China amongst the so-called party economic experts. The reform position (loosening of capital controls,market rather than state benchmarks, eliminating the hukou--population mobility restraints) and those who feel the reforms are anathema and China should return to its Stalinist state control economic policies. Hence the Bo Xilai debacle. (I have posted this before here so forgive my repetition).

Thus, this situation is a litmas test for some and a do or die scenario for others in the power circles.

Complicating the economic landscape is the fact that they themselves do not know the extent of the rehypothication of assets/ the extent of shadow financing/ nor the money laundering, mal-investment or flight of capital. Trials for corruption of top officials has accelerated. But at the end of the day, this new turn by the CB is an attempt to shake the tree to see what fruit may fall.

It may also set off a disasterous unwinding ( now that word is cute ) of the economy.

Chindit is right for calling this a Potemkin scenario.And remember Grigory Potemkin erected those fake villages along the Dneiper river to fool the Russian Empress Catherine II at her visit to the Crimea.


Greenskeeper_Carl's picture

Ha no problem for me, I feel like I've been doing that pretty much constantly, since last April at least

LetThemEatRand's picture

Douchebag war.  This world economy has that not so fresh feeling.

zhandax's picture

You mean Yellen doesn't have that 'New Car Smell'?

Groundhog Day's picture

Geez I didn't hear a kaboom or anything....tyler are yiu s u re its a collapse

Johnny Cocknballs's picture

dear junkers - please remember this junk, okay, and we'll see if you, or me, is right.


fonzannoon's picture

fwiw i'm not one of your red arrows.

Johnny Cocknballs's picture

didn't think so and no worries if you had, my good Fonz.  Replied further above. 

Not my wheelhouse so I take junks/replies very seriously.  Pretty much sticking to my story on this one though.

also note that I didn't junk you.

TeamDepends's picture

May you swim in interesting current(cy).

Buck Johnson's picture

The liquidity trap/circle is in full effect, it's feeding on itself now.  The more they try to stop it the more they try to get their money out etc. etc..

Johnny Cocknballs's picture

meh, give it a couple weeks.

things change fast.... 

Redneck Hippy's picture

B-b-but I thought the yuan was becoming  the new world reserve currency.   I read it right here on ZH.

LetThemEatRand's picture

Thus the slam down.   The big question is who wins.  The Western bankers just took a pawn.

Greenskeeper_Carl's picture

I think this is just Tyler being overly dramatic again. Kinda like gold is "surging" when it goes up 19 dollars all of a sudden, as if that somehow means its a trend

LetThemEatRand's picture

I had the same initial thought, but it is a dramatic move in a short time-frame.  Either way, we're fucked.  If PMs go up dramatically, the bankers will take 'em.  If they don't, the bankers laugh.  So long as bankers rule the world we're fucked.

Greenskeeper_Carl's picture

I'm sure ill get some reds for this, but I don't fear out right PM confiscation. We are still a relatively large gold mining country, and the ETFs allegedly hold a decent amount, as do the large privately owned storage vaults. I don't believe it will come to a point where they are kicking in doors to take a couple of ounces at a time from private citizens to take in the name of the govt or the federal reserve. Gunfire would ensue, and I do believe that even the most ardent statist will balk at the idea of risking their own lives to seize gold from their own neighbors. Maybe I am over estimating the intelligence and integrity of my fellow man, who knows

fonzannoon's picture


There will be no gold confiscation. The middle class already barfed it all up at the cash for gold store.

LetThemEatRand's picture

No confiscation.  Just taxes, if it goes up dramatically.  They don't take outright.  They skim.  A dollar from each person on the planet just once every month is close to $100B/year.  The Fed is just the ultimate expression of the Sham Wow.  Take a little from a lot and you own the lot.

EDIT:  sham wow guy didn't have stealth bombers and the Fed takes thousands of times as much.

Greenskeeper_Carl's picture

Ha ya you may well be right. All those old necklaces, ear rings, braclets, etc. All sold for a couple hundred a piece, melted into bars, and shipped off to china. All probably sold to get a few hundred dollars together to buy a huge TV of the newest Ishit.