Something very dramatic happened overnight to currency traders who were short the offshore Yuan, or the CNH: they were crushed by the Chinese Central Bank. Specifically, as we reported last night [6], the overnight HIBOR, or deposit rate in the offshore currency, aka the cort of borrowing Yuan in Hong Kong went from almost nothing to... 66%!
[7]
Using very colorful terms, a Rabobank strategist told Bloomberg that "a 66% rate is murderous for others being swept up in this who are not speculating." Earlier in the day, a PBOC advisor warned that short selling the yuan "will not succeed," adding that "it is pure imagination that the Chinese yuan will act like a wild horse without any rein."
Indeed, the PBOC quickly "reined in" the wild horse, but what is most interesting is how it did that.
Think Martin Shkreli and Kalo Bios.
Recall how the worthless stock soared from almost nothing first to $10, then to $20 before finally peaking in the mid-$40s: the reason for that is that Martin Shrekli, since arrested, proceeded to buy ever more of the KBIO float, making shorting first prohibitively expensive, and ultimately, impossible when he owned virtually all of the float.
The PBOC did just that overnight when it made the cost of shorting the CNH so high that every short had no choice but to cover and run, leading to the biggest squeeze in the CNY in recent history, and a parity between the onshore and offshore currencies.
[8]to patirty
Still confused? Here is Axiom's Gordon Johnson explaining what happened in more detail:
First... see this chart (i.e., 1 week HIBOR up a WHOOPING 200% overnight… WOW!!!):
What the Chinese government is doing is restricting access to the CNH market to bring the CNH back in line with the CNY.
How? Well, draining liquidity from the CNH market by selling dollars and buying CNH… then not providing any new CNH for the banks to lend (since the PBOC is the one who CREATES CNH, they can simply restrict the supply). On top of that, they are ordering commercial banks not to lend any of the remaining CNH they may have to short sellers.
Thus, as stated above, this has the side effect of making the currency totally unusable… so presumably they won’t allow this state of affairs to continue for long.
But their immediate priority was to bring the CNH back into line with CNY (I mean, their whole pitch for SDR inclusion was that the CNH would track the CNY, so even though the currency isn’t fully convertible, investors/central banks/whoever could own something that was the equivalent of owning the currency – before this recent experiment, THIS IS NOT THE CASE).
So, in our view, now they will oscillate back and forth between draining liquidity (when the CNH weakens vs. the CNY) and adding liquidity back (to make the market function).
They hope, I guess, that there’s some magical point they can find where the CNH doesn’t sell off but the market still functions? We are taking the “other side” of this bet.
How does it all end? Well, we know that despite Martin Shrekli's attempt to manipulate KBIO stock higher, the company - which had no fundamental value - went bankrupt just one month after Shrekli's manipulation. As for Shrekli, he is arrested pending charges of fraud, and could spend many years in prison.
As for China's attempt to repeat what Shkreli (and Volkswagen management before him) did, we doubt the ending will be any happier.
