Hedge Fund Which Predicted The Subprime Crisis Expects Massive Yuan Devaluation In 2016

Tyler Durden's picture

Earlier this month, even before China unleashed the end phase of its latest currency devaluation which since forced the PBOC to enforce even more capital controls to avoid accelerating capital outflows, Kyle Bass revealed that his best investment idea for 2016 was to short the Chinese currency:

"Given our views on credit contraction in Asia, and in China in particular, let's say they are going to go through a banking loss cycle like we went through during the Great Financial Crisis, there's one thing that is going to happen: China is going to have to dramatically devalue its currency.... "We are not short Chinese equities, but we are very invested in the Chinese currency: we think we are going to see a pretty material devaluation; we think it's going to be in the next 12-18 months."

He did not specify exactly what he means by "pretty material devaluation" however according to our own December calculations, an indicative number is likely in the 10-15% ballpark.

Today, another Texas-based hedge fund manager who just like Kyle Bass correctly predicted, and profited from, the subprime crisis, Corriente Advisors' Mark Hart, has not only reiterated Kyle Bass CNY devaluation call, but has gone as far as quantifying by how much the Chinese currency will have to fall. Cited by Bloomberg, Hart has said that "China should weaken its currency by more than 50 percent this year."

Hart believes that the Chinese crawling devaluation is an error as it carries with its the latent threat of much more devaluation in the future, thus encouraging even more outflows, which in turn forces China to sell even more reserves, which destabilizes the economy even further, forcing even more devaluation and so on.

Instead, a one-off devaluation would allow policy makers to “draw a line in the sand” at a more appropriate level for the yuan, easing pressure on China’s foreign-exchange reserves and removing an incentive for capital outflows, according to Hart, who’s been betting against the currency since at least 2011. He adds that China should devalue before its $3.3 trillion hoard of reserves shrinks much further, he said, because the country can still convince markets it’s acting from a position of strength.

Incidentally, this is precisely what Ex-PBOC adviser Yi Yongding says yesterday China should do, as quoted by the 21st Century Herald, adding that the PBOC’s forex reform in Aug. 2015, known as “crawling peg” by foreign investment banks, has many flaws and should be abandoned. Accoding to Yi, the scheme won’t be able to break mid- or long-term depreciation expectations because those are decided by fundamentals, even if they are misinterpreted. His conclusion is a widely accepted one by now, namely that China may not have better choice but to strengthen control over capital flows to stabilize financial market.

Back to Hart who says that "there wouldn’t be anything underhanded about a sharp devaluation. Why should China be forced to suffer deflationary effects of defending its currency when everyone else isn’t?"

In other words, why peel the bandaid one millimeter at a time when China should just rip it off in one motion?

Here's a reason why: or rather over 20 trillion reasons, which is how much in dollar equivalent deposits Chinese savers have parker at their local banks. If those depositors realize that their net purchasing power for foreign goods and services has suddenly lost 50%, in the words case, there would be riots in China, and in the best case an unprecedented capital outflow. Which is also why China has been so unwilling to do the "bandaid" approach.

As Bloomberg adds, Hart, whose prescription clashes with consensus forecasts for the yuan and recent comments from senior government officials, said China would be justified in weakening the currency after central banks in Europe and Japan fueled declines in their exchange rates to stoke economic growth in recent years. Such a move would likely come as a surprise to global investors, who were rattled by a drop of less than 3 percent in the yuan last August.

“They’re trying to drive a car with one foot on the brake,” said Hart, who estimates the People’s Bank of China spent more than $100 billion supporting the yuan in onshore and offshore markets during the first 12 days of January. “If China were to devalue to a level that wasn’t actually a true equilibrium they will get run over pretty quickly, they will blow through FX reserves, and then they will lose face because they’ll be forced to devalue.”

There is another implication from a sharp devaluation: a world in which not even the IMF can deny any longer that a full blown currency war has broken out. Bloomberg adds more:

While a one-off drop in the yuan could ease selling pressure on the currency and support exports, it would also entail risks for China and the rest of the world. Chinese borrowers have amassed $1.5 trillion of foreign-currency debt, according to an official estimate at the end of September, which would become instantly harder to repay after a sharp decline in the yuan.


A devaluation could also fan fears of a global currency war -- a risk that Mexico’s finance minister cited earlier this month -- and spur the U.S. Federal Reserve to backtrack on plans to raise interest rates, according to Hart.

For now, Chinese policy makers have signaled there are no plans for a big drop in the yuan. Premier Li Keqiang on Friday pledged a “stable” exchange rate and said the nation has no intention of stimulating exports through a competitive devaluation. Bets against the currency will fail and calls for a large depreciation are “ridiculous” as policy makers are determined to ensure stability, Han Jun, the deputy director of China’s office of the central leading group for financial and economic affairs, said last week in New York.

However, while in August 2015 China did engage a modest one-off devaluation, there is a precedent for a far sharper devaluation. The currency slid 33 percent at the start of 1994 as authorities unified official and market exchange rates, and the yuan has stayed stronger than that level ever since March of that year. That decision was a “wild success,” helping to set the stage for years of economic growth and foreign-exchange inflows, said Hart, who founded his hedge fund in 2001.

While a devaluation this year would be “jarring” and may initially accelerate capital outflows, it would ultimately put China in a stronger position, according to Hart. He said the country could explain the move by saying it would put the yuan at a level more reflective of market forces and allow the currency to catch up with declines in international peers.

It would also most likely unleash another global currency crisis, first among the Emerging Nations, and then among their Developed peers, as country after country scrambled to implement comparable currency destruction as China, in order to preserve their relative share in dwindling global trade, where the shortest way to boost one's exports has over the past 7 years, been a very simple one: destroy your currency faster than your exporting competitors.  

The reality, however, is that Hart is correct, and China will have to pick one option: either a sharp devaluation, or failing that, debt defaults: the current course of gradual CNY debasement will only results in an acceleration in capital outflows until ultimately China's $3 trillion rainy day fund is whittled away to nothing (and as a reminder, according to some estimate just a little over $1 trillion in it is actually liquid assets).

Hart is not alone in predicting a massive Yuan devaluation: Carlyle Group’s Emerging Sovereign Group in New York and Omni Partners in London are also positioned for a retreat in the currency. Crispin Odey, who runs Odey Asset Management, said in September that the yuan should fall by at least 30 percent.

Finally, this is how Hart is trading the upcoming devaluation: Hart said he’s wagering against the currency with put options, contracts that provide the right to sell at a specific price within a set period. Bets on a sharp devaluation aren’t common among his hedge fund peers, who only recently started to wager on a gradual depreciation, Hart said. 

“It strikes me as odd that the world would assume that China wouldn’t pursue same the same type of monetary policies” that led to weaker exchange rates in other nations, Hart said. “They’re between a rock and a hard place.”

Which is 100% correct, and is also why the market is finally starting to pay attention to the China in the bull store, after years of stubbornly ignoring it.

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Mr.Sono's picture

its called hedging

Durrmockracy's picture
Durrmockracy (not verified) Mr.Sono Jan 19, 2016 7:22 PM

....and anyone who hedges this collapse is going to be called "a hog" by The Free Shit Army.  Be ready!

philipat's picture

So more deflation imported into the US? And even more QE in response?

I personally don't think this will happen because the Yuan is NOT a freely floating currency so PRC can peg it exactly where it wants it and the "Cost" of so doing is zero.

NDXTrader's picture

It's not zero. By some accounts the Chinese have spent $500 billion of their reserves propping this turd up in just the last month. That's the whole point of the article - it would be smarter to just do one big devaluation in the dark of the night than this drip drip drip because people keep trying to get their money out expecting a small devaluation each night. They need to rip the band-aid off to try and stop outflows

aeslong's picture

don't forget that is so easy and effective for Chinese government to implement capital control.

newbie vampire's picture

" it would be smarter to just do one big devaluation in the dark of the night than this drip drip drip"

It would be the smart thing to do.  PRC needs a competitive advantage for its exports while keeping the work force exployed and buys time for the CPC to bring in economists who understand how to cope with their overhanging problems.  It diminishes the value of their mountains of bad debts, ballooning Yuan credit, makes their ghost apartment blocks more affordable to the masses of greater fools and also give a lift to the Stawk Exchanges.

But who expects politicians whether elected or unelected to do anything sensible.  I believe the CPC will continue with their current monetary policies until they run down all their reserves.

remain calm's picture

China, markets are starting to not ignore. Well, how about Japan, its a living abortion.

g3h's picture

Not going to happen dude.

scintillator9's picture

Had someone told me about NIRP seven years ago, I would have said the same thing.


LowerSlowerDelaware_LSD's picture
LowerSlowerDelaware_LSD (not verified) Jan 19, 2016 7:04 PM

"Fortunately" for the Chinese, they all have "free" health care in their communist utopia (although more capitalistic than the U.S. in many ways) so they don't have anything to worry about...

Jug Jugette's picture

"Free" health care? Whose bowl of noodles you bin slurpin'?

LowerSlowerDelaware_LSD's picture
LowerSlowerDelaware_LSD (not verified) Jug Jugette Jan 19, 2016 9:25 PM

Scare quotes.  A good reference for them is here: https://en.wikipedia.org/wiki/Scare_quotes


Cognitive Dissonance's picture

Devaluing by 50% would be considered round two of the currency wars.

You don't want to see round three.

pakled's picture

This is setting number 1 ... anyone want to see setting 2?


or 3??




DirkDiggler11's picture

No shit, really going out on a limb here aren't they ?

Is anyone not expecting massive de-valuation in the Yuan ?

Joe Sixpack's picture

I predict Sarah Palin will endorse Donald Trump for President!

Winston Churchill's picture

Will she pet his wombat while doing it ?

nmewn's picture

"I am being told to reiterate once again, we believe in very firm & strong yuans here! " - Vice Public Security Minister Meng Qingfeng

Cognitive Dissonance's picture

"When it becomes serious, you have to lie."

<So if you want to know how serious it is, check to see if they are lying.>

nmewn's picture

Yeah well, I can pretty much tell they're lying cuz they're Chi-Coms...it's just easier for me to be "closed minded" about these sort of things...lol.

At some point they will let their nationalized stawk market go.

Further ;-)

Winston Churchill's picture

I remember Harold Wilson saying the exact same about the pound.

What happened the next week is in the history books,

pakled's picture

Vice Public Security Minister Meng Qingfeng"


Little known fact.. close relative of Bagdad Bob

newbie vampire's picture

""I am being told to reiterate once again, we believe in very firm & strong yuans here! " - Vice Public Security Minister Meng Qingfeng"

Candidate for the deepest Coal mine.

Wild Theories's picture

yes that's what China should do, but would it do that?

besnook's picture

it is really a question of who wins the currency war. they are making the bet the dollar will win. that is not a sure thing. the dollar goes down in market corrections.

arbwhore's picture

In a currency war, the "winner" is the guy who devalues first and fastest. The US is WAAYYYY behind the rest of the world... suckers.

besnook's picture

not in this currency war. the strong dollar is aimed at crushing the brics and the countries aligned with them. china is trying to get the dollar to devalue.

newbie vampire's picture

"the strong dollar is aimed at crushing the brics"

The BRICS are already past their use by date.  The PRC's obstinacy to accept a devaluation will set them back 20 years.  They ain't got enuff reserves to sort out their own internal banking and shadow banking bad debts, let alone defend the Yuan.

There's no way out.

Comrade President Xi has also accumulated a heck of a lot of ill-will with his anti-corruption drive.  Other comrades may soon be baying for his blood.

besnook's picture

it is kinda easier than that. follow the template for the '97 asian currency rout and russia's default in 1999. the asian have been preparing for this attack since then. i wouldn't be surprised if china is helping out key allies with backup dollars. if the dollar weakens a lot of pressure is taken off the brics. the dollar weakens every time the market crashes. the market is crashing.

Winston Churchill's picture

Just as well we are no longer in the currency war stage,different rules for economic warfare.

arbwhore's picture

Export that deflation, bitchez.

Dragon HAwk's picture

I saw a Dollar Store once with big signs  in the windows.. Everything 50% off....

 would have been the perfect JPG for this article...

Yen Cross's picture

       I think cny is going lower, but 50% is a pretty big call. The cny is roughly 20% of the $usdx basket so even an 10% drop has huge implications.

 Here comes that massive wave of deflation from Asia.

xxxxx's picture

50% would collapse all currencies against the dollar. Given what is happening in China one large devalulation is not farfetched at all.

Yen Cross's picture

 That serves no purpose, to do one massive devaluation. China has been selling UST to avoid just that scenario.

 Just a 10% devalue of cny would mean an additional 5% strengthening of the $usd already trading just below the 100 handle on the $usdx.

Catullus's picture

It's only an FDR-like devaluation. It's not like respectable currencies like the dollar pegged to gold ever did anything like this.

I am a Man I am Forty's picture

won't that like, starve their population at the same time

Lore's picture

Re: "While a devaluation this year would be “jarring” and may initially accelerate capital outflows, it would ultimately put China in a stronger position...the country could explain the move by saying it would put the yuan at a level more reflective of market forces and allow the currency to catch up with declines in international peers."

That's the most glaring bit of intellectual dishonesty I've read in a long time.  They're deciding between the banks and the people, and choosing the banks.  Not very Chinese of you, China. 

Seasmoke's picture

The world has proven itself to be crazy. How everyone is still not running to safety of Gold is beyond me !!!

Jason T's picture

King Dollar : )  : / 

UncleChopChop's picture

any of you smart people have opinions on how the AUD ought to fare in the eventuality of a sharp chinese deval? seems like concensus has been thinking low 60s as a 12m target, but presumably that doesn't take into account a big chinese move.

Wild Theories's picture

not a smart fx guy, so don't know where AUD should be, but do know it will follow CNY down

which is probably what you already know

ZombieHuntclub's picture

Good thing Lagarde added the yuan to the basket of currencies! She's so smart. I'd let her have my  babies. 

chairman mao's picture

Soros and gang vs PBOC, who you pick?

aeslong's picture

It seems that he lost massive money in short CNY, and is trying to talk down to wind position down. Betting against China central bank has never been working, even Soros beard huge loss in betting against HK dollar and stock market during 97 Asian crisis.

Diablo's picture

When's Golden Week? (wink wink)