China Will Devalue The Yuan To Pay Bills

It is difficult to stick to an "extreme" position when most of the popular opinion is on the other side, doubly so when one readily admits that short-term factors are moving in the opposite direction. I have remain steadfast in my opinion that the yuan faces great devaluation pressures, even as it has risen post-2008, and even substantially so. My preferred strategy would be to buy very low cost options on yuan devaluation, a strategy that is unavailable to retail investors.

China's central govt fiscal revenue growth slows

For instance, revenue from value-added tax in the domestic market only met 97.2 percent of the budgeted target because industrial performance was poor.

This year, the central government may be under great pressure to achieve the full-year target of 7-percent growth, Finance Minister Lou Jiwei said when elaborating on the report.

In the first four months of the year, central fiscal revenue dropped by 0.8 percent from the same period last year, largely due to a slowdown in economic growth and structural tax reductions, according to the report.

In the next few months, industrial output growth may continue to slow down and enterprises may report less profits, which will set back fiscal revenue growth, Lou said.

A pilot program to replace the business tax with a value-added tax (VAT) in some service sectors will be expanded to the whole country in August, which will likely reduce central government revenue, he added.

Since the beginning of last year, China has adopted a raft of tax-cutting measures to help alleviate burdens for businesses and individuals and serve the country's economic restructuring.

There is nothing wrong with their strategy of cutting taxes, but it can become expensive if they don't have a way to pay for it.

State Council vows revenue reform

A State Council executive meeting Wednesday pledged to further revitalize existing fiscal revenue and make use of idle capital, as the growth of China's fiscal revenue has slowed and some areas have even seen a drop in fiscal revenue.

What is idle capital in a nation starved for capital, where private interest rates can exceed 10%? Foreign exchange reserves.

Closer Look: What to Do about the Huge Shortfall in Tax Revenue (subscription required, may become free later)

If the government makes better use of the funds it has and

dips into the huge reserves in the central bank

, it and the economy will benefit

If China starts spending down their foreign reserves and the economy booms as a result, the devaluation of the yuan will be avoided. Once they tap reserves though, it will be the crossing of the Rubicon. If the economy does not recover, they will try spending more and those reserves will be depleted rapidly once investors do the math and start pulling U.S. dollars out of China.