Chinese yuan crash underway

Get ready for a rocking 2012 as this could be the story of they year—if it pans out. I have been talking about the possibility of a depreciating yuan for several years, but the story heated up in December as the yuan traded limit down for several days in a row. This exposed the central banks maneuvers to prop the yuan up, but now ZeroHedge is reporting on this story and saying that the market has been trying to weaken the renminbi in a major way this autumn.

Intraday USDCNY Unchanged Since 2006
While all has been calmly proceeding in the right direction from US perspectives with CNY appreciation (though maybe not fast enough for Chuck Schumer's liking), under the surface there is what appears to be a fierce battle between market participants and the PBoC. By breaking down the cumulative shift in USDCNY into intraday 'market/trading' movements (from fixing to close) and interday 'government-assisted' movements (from prior close to fixing), we can draw some perspective on what the market is trying to do and what the government is doing. Evidently from the chart, the outward appearance that CNY appreciation is slowly but surely occurring (the green line) is misleading, the clear signal is a market trading the USD higher (helped by European angst) and a PBoC massively intervening.

The ZeroHedge headline implies that the cumulative intraday move in the renminbi has completely erased appreciation since 2006, which means the cumulative move would have pushed the renminbi back to 8:1 U.S. dollar. I don't believe this is the correct interpretation because the government is forcing the currency lower and the market is pushing against this in the short-term and intraday, not over the long-term. This gap implies the government is fighting the market in a major way, but it doesn't give us a good price target. What this chart clearly shows is that the yuan price has been falling this autumn. The action in December, of several days in a row of limit down trading, was market forces finally overwhelming the People's Bank of China.

Notice there was also a crash in 2008, but this was a small move and the PBOC eventually "won" the day because the market again moved in its direction. Market intervention by central banks works when the market is moving with it as shown in Illusion of Control: Central Banks and Interest Rates. Since 2009, the Federal Reserve has failed because it is fighting the market, rather than following it. Many investors wrongly believe the Chinese have more power over markets than Western governments. They have more control over markets in the short-run, but ultimately markets always win. There will be a large psychological shock to the market if the PBOC is seen to have lost control of the renminbi. However, at this moment there is just a lot of smoke. This isn't yet a fire and if the markets move back in the PBOC's favor, it will have "won" again this time, like they did in 2008, as the market traded along with the government in 2009, 2010 and the majority of 2011. Unfortunately, this is a volcanic situation. There's no way to know if and when it will erupt, but an eruption will be devastating for global markets.

Here are recent blog posts I've written on the weak yuan; all of these post have come in the past month. Before this period, I may have only covered this topic once every three or six months, if that much, but events are starting to move now. Use the renminbi tag to see all the blogs written on the topic.

11/10 Yuan can go down
11/17 China's forex weaker than perceived
11/24 Chinese yuan now flowing out of Hong Kong
11/26 Buy puts on the yuan?
11/30 Yuan crash possible?
12/07 Yuan hits limit low for fifth straight day
12/08 Yuan limit down for seventh straight day
12/15 Yuan limit down again; 12th day of losses
12/19 Devaluing the renminbi

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