China Daily agrees: the yuan can go down

Last autumn in Chinese yuan depreciation coming soon?, I wrote:
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.
Being a bear on Chinese currency appreciation was a lonely position for a long-time. I do not believe there were many bears actually shorting the yuan, with government directed appreciation behind it, but from a trading perspective, an 8% drop in the yuan would erase all of the gains since the yuan started appreciating again in 2010. I expect that is well within the range of possibilities because as I also wrote,
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.
When major economic trends start reversing, it doesn't necessarily lead to volatility, but when central banks are printing trillions of dollars, those trends form the foundation of many economic and financial models, and most people assume those trends will continue, you have the recipe for a violent readjustment.

The Chinese have been openly discussing a weaker yuan since last year, but now it is reaching a wider audience. See Yuan to face downward pressure in 2012
The yuan will be under increasing downward pressure in 2012, and the increase in yuan holdings for foreign exchange purchases and the investment growth rate will both decline by more than half, a senior researcher close to the authorities said on Wednesday.

Liu Yuhui, director of the financial laboratory at the Institute of Finance & Banking at the Chinese Academy of Social Sciences, a prominent central government think tank, said he had obtained these forecasts from the central bank.
Currencies don't fluctuate their trend, they tend to have very long trends and fluctuate around them. Therefore, we're either going to see "messier" yuan appreciation or an end to the appreciation in the yuan. Since a multi-year decline in the yuan seems unlikely at this point, the odds favor a messy appreciation, with growing (but still small) odds of a catastrophic plunge in the value of the renminbi.
Regarding external conditions, he said although yuan holdings in January had increased, the growth for each month will decline to somewhere below 150 billion yuan ($23.7 billion) in 2012, in contrast with 250 billion to 300 billion yuan in the past five years.

For 2012, the total increase in yuan holdings will shrink to 1.5 trillion yuan, compared with an average of 3 trillion yuan in the past five years.

Banks' holdings for purchasing foreign exchange, an indicator of capital flows, fell for the first time in four years in October by 25 billion yuan. Holdings declined again in November by 28 billion yuan, and again in December by an even larger 100 billion yuan. In January, however, holdings rose nearly 141 billion yuan.

The domestic situation was also changing, he said, as the past pattern of fiscal expansion will not continue.

"In that respect, the change will be reflected in a dive in the investment growth rate, which will drop to about 12 percent - the level when (former premier) Zhu Rongji led the cabinet - from about 23 percent in recent years," Liu said.

Judging by figures for new yuan loans by banks, which have been running below expectations, the tendency was very clear, he said.

Despite these trends and changes, he said, the yuan might not depreciate this year. The central bank will use its dollar holdings to support the currency if necessary, he said.
Read that sentence a few times. There's a vocal chorus of people who assume that anytime China (or anyone for that matter) sells U.S. dollars, it is bad for the greenback and signals an end to the U.S. dollar's status as reserve currency. This is muddled thinking however, since it very much matters whether one sells from a position of strength or weakness. Thailand, Malaysia, South Korea and Argentina before them spent their foreign reserves trying to defend their currencies and no one thought that was bearish for the U.S. dollar, in fact it was extremely bullish. China's situation is different today. The most likely reason for them to support the currency is political—they want to avoid a trade war with the United States and Europe—but should the economy weaken or another global financial crisis erupt, they may be forced to defend the currency. Either way, the renminbi is much weaker today than it is popularly perceived to be and at risk, in the event of a "surprise" contagion, of a swift decline.

For background, also see China's forex weaker than perceived.

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