Thursday, January 21, 2016

Chinese currency run - some thoughts

The big elephant in the room that people are scared of is an uncontrolled renminbi run. It's obvious we're seeing a bog-standard EM/commodity collapse, the last one ended with the 1997 Asian crisis, and wow what if that happened today with China being the second largest economy in the world OMG LOL BRB?

I just realized there's some problems with this.

First, in 1997, the countries hit had low currency reserves, and China's are huge. Sure, of China's $3 point something trillion, only $1.6 trillion might be immediately available with the rest tied up; but that brings up an important point that they seem not to teach us in (undergrad) economics.

There are upside limits to everything.

It's easy to break the Mexican peso or the Thai baht when they're supported by low reserves: you simply have to mobilize more capital than that central bank has.

But how do you mobilize over $1.6 trillion to slam the Chinese central bank? I don't think there's enough available money in the world to break the yuan. Maybe if every investment bank worked in unison, you might succeed; but then you run into the second problem, that any failure in co-ordination or defection from plan will leave the rest of the team high and dry.

Essentially, I don't see how China's central bank can get broken without a higher level of trust and co-operation than what you should normally expect from bankers. Especially not now, with the US equity markets providing an extra source of uncertainty.

Secondly, you would need to mobilize so much capital that your trade would be an existential threat to your own bank. And you're not going to get bailed out by your government when they find out you zeroed out your reserves to cause a geopolitical crisis, making Li Keqiang angry at your government, with a hoped-for side-effect of destroying your nation's net exports.

If you fail the trade, you're going to be living the rest of your life in exile in Madagascar. That might sound nice, but wait til you see the spiders.

And thirdly, you know the risk is going to be higher than it was for the 1998 peso slam, because China's government is known for doing slightly crazy things with the intent of punishing their enemies. You don't want to go $100 billion short yuan long USD and then see China slam you 3% in overnight markets, then impose capital controls, then send the police to pay a visit to your Beijing office. Risk/reward has to be a lot lower.

So I just don't get how an immediate, fast, catastrophic yuan devaluation can happen.

It can still devalue with normal capital outflows, sure. Til the government shuts that door.

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