Chinese yuan depreciation coming soon?

I have previously argued that the yuan could drop, you can find posts under the renminbi tab. I was expecting a decline much earlier, but then I was also incorrectly bearish on the economy and the market as it rallied from 2009 all the way into mid-2011. The increase in the yuan has been slow, steady and managed, lulling many investors into a false sense of security. Outside of the vocal China bear crowd, which tends to overlap heavily with deflationist and/or followers of the Austrian school, the overwhelming consensus assumes yuan appreciation.

On the front page of the Economic Observer this weekend are several articles on the yuan: 人民币拐点临近? (Renminbi turning point approaching?); RBS:人民币贬值可能性大为加强 (Possibility for yuan depreciation increases); 人民币汇率与央行的面子 (Renminbi and the central bank's "face"). The gist of these articles is that the renminbi is close to fully valued, U.S. pressure on China to appreciate the currency is unrealistic and not backed up by the facts, and a small depreciation is even possible.

I don't expect yuan depreciation will be slight because it will happen when hot money flows out of the renminbi and economic indicators, most importantly the trade surplus, reverse. It seems like every time there is a bubble, there are people explaining how it will be limited, the impact will be concentrated in housing/stocks/Greece and so on, and this is almost always wrong. Also important to watch is the political angle. If the renminbi doesn't continue to appreciate, U.S. politicians will become more open to the idea of retaliatory tariffs. This is why China's policy makers are in a bind. What happens if the yuan needs to depreciate in the midst of a crisis? U.S. politicians will be open to extreme policy choices during a crisis, such as the TARP plan that many were cajoled into voting for. Conversely, if the Chinese do not depreciate the yuan in a deflationary crisis, the economy will experience crushing deflation. This is why Liu Jun Luo warns that hyperinflation may be on the way if the Chinese do not inflate now.

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