Rickards Warns "Prepare For A Chinese Maxi-Devaluation"

Authored by James Rickards via The Daily Reckoning,

China is a relatively open economy; therefore it is subject to the impossible trinity.

China has also been attempting to do the impossible in recent years with predictable results.

Beginning in 2008 China pegged its exchange rate to the U.S. dollar. China also had an open capital account to allow the free exchange of yuan for dollars, and China preferred an independent monetary policy.

The problem is that the Impossible Trinity says you can’t have all three. This model has been validated several times since 2008 as China has stumbled through a series of currency and monetary reversals.

For example, China’s attempted the impossible beginning in 2008 with a peg to the dollar around 6.80. This ended abruptly in June 2010 when China broke the currency peg and allowed it to rise from 6.82 to 6.05 by January 2014 — a 10% appreciation.

This exchange rate revaluation was partly in response to bitter complaints by U.S. Treasury Secretary Geithner about China’s “currency manipulation” through an artificially low peg to the dollar in the 2008 – 2010 period.

After 2013, China reversed course and pursued a steady devaluation of the yuan from 6.05 in January 2014 to 6.95 by December 2016. At the end of 2016, the Chinese yuan was back where it was when the U.S. was screaming “currency manipulation.”

Only now there was a new figure to point the finger at China. The new American critic was no longer the quiet Tim Geithner, but the bombastic Donald Trump.

Trump had threatened to label China a currency manipulator throughout his campaign from June 2015 to Election Day on November 8, 2016. Once Trump was elected, China engaged in a policy of currency war appeasement.

China actually propped up its currency with a soft peg. The trading range was especially tight in the first half of 2017, right around 6.85.

In contrast to the 2008 – 2010 peg, China avoided the impossible trinity this time by partially closing the capital account and by raising rates alongside the Fed, thereby abandoning its independent monetary policy.

This was also in contrast to China’s behavior when it first faced the failure of its efforts to beat impossible trinity. In 2015, China dodged the impossible trinity not by closing the capital account, but by breaking the currency peg.

In August 2015, China engineered a sudden shock devaluation of the yuan. The dollar gained 3% against the yuan in two days as China devalued.

The results were disastrous.

U.S. stocks fell 11% in a few weeks. There was a real threat of global financial contagion and a full-blown liquidity crisis. A crisis was averted by Fed jawboning, and a decision to put off the “liftoff” in U.S. interest rates from September 2015 to the following December.

China conducted another devaluation from November to December 2015. This time China did not execute a sneak attack, but did the devaluation in baby steps. This was stealth devaluation.

The results were just as disastrous as the prior August. U.S. stocks fell 11% from January 1, 2016 to February 10. 2016. Again, a greater crisis was averted only by a Fed decision to delay planned U.S. interest rate hikes in March and June 2016.

The impact these two prior devaluations had on the exchange rate is shown in the chart below.


Major moves in the dollar/yuan cross exchange rate (USD/CNY) have had powerful impacts on global markets. The August 2015 surprise yuan devaluation sent U.S. stocks reeling. Another slower devaluation did the same in early 2016. A stronger yuan in 2017 coincided with the Trump stock rally. A new devaluation is now underway and U.S. stocks may suffer again.

By mid-2017, the Trump administration was once again complaining about Chinese currency manipulation.

This was partly in response to China’s failure to assist the United States in dealing with North Korea’s nuclear weapons development and missile testing programs.

For its part, China did not want a trade or currency war with the U.S. in advance of the National Congress of the Communist Party of China, which begins on October 18.

President Xi Jinping was playing a delicate internal political game and did not want to rock the boat in international relations. China appeased the U.S. again by allowing the exchange rate to climb from 6.90 to 6.45 in the summer of 2017.

China escaped the impossible trinity in 2015 by devaluing their currency.

China escaped the impossible trinity again in 2017 using a hat trick of partially closing the capital account, raising interest rates, and allowing the yuan to appreciate against the dollar thereby breaking the exchange rate peg.

The problem for China is that these solutions are all non-sustainable.

China cannot keep the capital account closed without damaging badly needed capital inflows. Who will invest in China if you can’t get your money out?

 

China also cannot maintain high interest rates because the interest costs will bankrupt insolvent state owned enterprises and lead to an increase in unemployment, which is socially destabilizing.

 

China cannot maintain a strong yuan because that damages exports, hurts export-related jobs, and causes deflation to be imported through lower import prices. An artificially inflated currency also drains the foreign exchange reserves needed to maintain the peg.

Since the impossible trinity really is impossible in the long-run, and since China’s current solutions are non-sustainable, what can China do to solve its policy trilemma?

The most obvious course, and the one likely to be implemented, is a maxi-devaluation of the yuan to around the 7.95 level or lower.

This would stop capital outflows because those outflows are driven by devaluation fears. Once the devaluation happens, there is no longer any urgency about getting money out of China. In fact, new money should start to flow in to take advantage of much lower local currency prices.

There are early signs that this policy of devaluation is already being put into place. The yuan has dropped sharply in the past month from 6.45 to 6.62. This resembles the stealth devaluation of late 2015, but is somewhat more aggressive.

The geopolitical situation is also ripe for a Chinese devaluation policy. Once the National Party Congress is over in late October, President Xi will have secured his political ambitions and will no longer find it necessary to avoid rocking the boat.


China’s President Xi Jinping awaits appointment to a second term at the 19th National Congress of the Communist Party of China, starting October 18. His reappointment is a foregone conclusion.

China has clearly failed to have much impact on North Korea’s nuclear weapons ambitions. As war between North Korea and the U.S. draws closer, neither China nor the U.S. will have as much incentive to cooperate with each other on bilateral trade and currency issues.

Both Trump and Xi are readying a “gloves off” approach to a trade war and renewed currency war. A maxi-devaluation of the yuan is Xi’s most potent weapon.

Finally, China’s internal contradictions are catching up with it. China has to confront an insolvent banking system, a real estate bubble, and a $1 trillion wealth management product Ponzi scheme that is starting to fall apart.

A much weaker yuan would give China some policy space in terms of using its reserves to paper over some of these problems.

Less dramatic devaluations of the yuan led to U.S. stock market crashes. What does a new maxi-devaluation portend for U.S. stocks?

We might have an answer soon enough.

Comments

Stan Smith Fri, 10/13/2017 - 20:39 Permalink

Getting the yuan in the 'basket' with the rest of these currencies will help from an accounting point of view.     But in the end, it certainly appears that all the Central Banks are simply racing to see who can print the most money. "Everything is Awesome"

yvhmer cbxer55 Sat, 10/14/2017 - 10:59 Permalink

Someone was vexed, terribly vexed. Glad that post is gone.Ah.... Now hear a French woman exclaim: " Imbicile", and bitchslapping the full retard! ;-), followed by: Andouille!As to the article, it seems that everybody is in the " catching off flies here. So, be scared, very scared.  I love fearporn on Saturdays. 

In reply to by cbxer55

TeethVillage88s Fri, 10/13/2017 - 20:57 Permalink

Safe Bet! Since we had one in 2015!

- this is not Rocket Science!
- This happened before!
- This has already be proved that China Effects the US Stock Market
- Took more than a year to recover from Chines Yuan Devaluation and Stock Market Struggle which ever came first doesn't matter much

TeethVillage, Rocket Scientist, Stock Market Loser

HoserF16 Fri, 10/13/2017 - 21:03 Permalink

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rwmctrofholz Fri, 10/13/2017 - 21:42 Permalink

I suddenly got the urge to read a book on currency wars.  If only there were an author out there who wrote such pieces and could sell me an overpriced book....

napper Fri, 10/13/2017 - 22:41 Permalink

Now that Jim Rickards is predicting it, you know it's not going to happen any time soon (like in the next 10 years at least).  

Sorry_about_Dresden Fri, 10/13/2017 - 23:46 Permalink

A chart of rmb vs dollar tranposed on s&p 500 chart would have been a nice graphic to tell the story.Xi must also consider devaluing rmb too drastically makes all those nifty German imports much more expensive, and I know how the PRC loves German gear. Good old Thyssen-Krupps labels all over the train platforms in PRC, the high speed rail is also German gear, and let's not forget the Beemers that are in parking deck under all those new apartments!So, I have to believe it is a delicate balance. The EURO is somewhat tied to USD, as is the rmb, so PRC must be careful, walk a fine line, if they devalue too much, then they can't afford all that nifty gear.PRC is done with the USA, she only re-ups on UST debt so she can support rmb-EURO scheme, she don't care about the old whore USA, Prc is done wit US!Right???????

peterk Sat, 10/14/2017 - 01:54 Permalink

The reasoning  in the article is flawed.why would china want a lower yaun?To capture more market share  with exports????...... they already have  all the export trade they want or need. They dominate world trade.China does NOT want more Trade, it wants RESERVE status. Thats where the money is.!You dont  get to be  RESERVE currency with the most worthless currency on the  tableyou get it with the mpost  EXPENSIVE currency on the table. 

Hubbs peterk Sat, 10/14/2017 - 09:19 Permalink

Do you get Reserve Currency status when your currency is most readily and widely used? Yes of course. But how does it get there? Doesn't it get there by being asset backed as the USD was before 1971, or when you destroy everyone else's currency and make yours the winner by default ?

Whether your currency is "expensive" or not does not necessarily mean that it can be a reserve currency.

Asset backed might also imply that your country makes material things which would also back the currency.

In reply to by peterk

post turtle saver Hubbs Sat, 10/14/2017 - 10:31 Permalink

you stupid fucks... there aren't enough assets available in 100 Earths to back all the currency transaction activity that takes place in modern markets...gold bugs are about the dumbest sonsabitches going... the US et al have _already tried_ gold backed blah de blah and it fucking fell apart because there wasn't enough gold or US dollars to back transactions or trade... no one could *** take delivery *** you idiots...what's funny is everyone bitching and moaning about wanting the reserve currency to be something other than the USD... all I can say to that is PLEASE go ahead and take on that role, it's been a horrible burden for the US for over 40 years... oh please, not the briar patch lol

In reply to by Hubbs

Batman11 Sat, 10/14/2017 - 04:22 Permalink

Keynes in 1914 wrote:“He could “order by telephone, sipping his morning tea in bed, the various products of the whole earth ….. he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises in any quarter of the world”One minute to midnight before the end of the last globalisation phase.The last great expansion of mankind before the inevitable contraction, a cycle that has repeated throughout history, the great civilisations and empires of history expand and then contract again.This phase of globalisation has been laid low by economic secrets.Monetary theory has been regressing since 1856, when someone worked out how the system really worked.Credit creation theory -> fractional reserve theory -> financial intermediation theory“A lost century in economics: Three theories of banking and the conclusive evidence” Richard A. Wernerhttp://www.sciencedirect.com/science/article/pii/S1057521915001477http://www.whichwayhome.com/skin/frontend/default/wwgcomcatalogarticles/images/articles/whichwayhomes/US-money-supply.jpgM3 is going exponential before 2008, a credit bubble is underway (debt = money)Ben Bernanke can see no problems ahead in 2007, he doesn’t know the money supply is equal to all the debt in the national system and can’t see a credit bubble has been blowing up.The US and UK don’t know that bank loans create money and the apparent success of their economies is really just the money creation of loading the economy up with unproductive lending into real estate and financial speculation.US:https://cdn.opendemocracy.net/neweconomics/wp-content/uploads/sites/5/2017/04/Screen-Shot-2017-04-21-at-13.52.41.png1929 and 2008 stick out like sore thumbs.UK:https://cdn.opendemocracy.net/neweconomics/wp-content/uploads/sites/5/2017/04/Screen-Shot-2017-04-21-at-13.53.09.pngThe unsustainable real estate and financial speculation economy makes itself apparent. They don’t know the difference between productive and unproductive lending.These graphs highlight unproductive lending into the economy and it causes financial crises.Productive lending goes into business and industry and gives a good return in GDP.Unproductive lending goes into real estate and financial speculation and it shows up in the graphs above as it doesn’t give a good return in GDP.No one knows the difference between “earned” and “unearned” income, wealth creation and wealth extraction. The US goes full tilt into building up a parasitic, rentier economy. “Income inequality is not killing capitalism in the United States, but rent-seekers like the banking and the health-care sectors just might” Angus Deaton, Nobel Prize winning economist, who only notices the problem when it is entrenchedThe economic secrets that are bringing an end to this phase of globalisation.

Batman11 Batman11 Sat, 10/14/2017 - 04:23 Permalink

With talk of the next financial crisis there is one more secret that only the FED seemed to know after 2008.Central Banks can clear bad assets from the banks with money they create out of nothing.The US banks at the epicentre of the crisis recovered the fastest.Central Banks were created to backstop the financial system and have the power to reflate the national banking system after a crisis with money they create out of nothing.After WW2, Japanese banks were in a terrible state and full of non performing war loans, they were technically insolvent. The BoJ bought their bad assets at full value and restored them, so they could get back to business. All done at no cost, the money came out of nothing and the bad assets went to die quietly on the BoJ’s balance sheet.This is something Central Banks can do and are designed to do. The people that unlocked the secrets and Japan 1989 was a great time to start for two of them that lived there at the time.Steve Keen - Minsky moments and affects of debt on the economyRichard Koo - After the Minsky Moment, studied 1929, Japan 1989 and 2008.Richard Werner - Money and debt, bank credit and how it must be allocated for economic success, studying Japan around 1989Michael Hudson - The history of economics, the difference between earned and unearned income  

In reply to by Batman11