Currency War: Battle of Hong Kong

PBOC, Traders Tussle Over Yuan (Alternate link)
A battle in China's currency market has emerged in recent days: Traders are pushing the yuan weaker, while the People's Bank of China has been attempting to guide the tightly-controlled foreign-exchange rate stronger.

..."China doesn't want to join the currency wars and that explains the fix movement," said Ju Wang, a currency strategist at HSBC Holdings PLC in Hong Kong, referring to some countries' efforts to push their currencies lower so that their exporters remain competitive. "But markets see it as China will eventually be dragged into the currency war or just fundamentally, growth and exports will weaken so much that will trigger the markets' demand for the U.S. dollar."
The PBOC stood aside on Monday and traders took the yuan down fast, then followed it up on Tuesday. By Wednesday they had enough and tried putting the squeeze on.

This may finally be the end of the road for China's currency policy. What the market is saying is that there are now consequences for monetary policy. Lower interest rates and the currency will weaken. Everyone knows there's no more one-way appreciation, as Chinese officials have made clear, but the Chinese central bank has moved on to battling volatility.

It's a good time to review The Informational Power of the Offshore Yuan Exchange Rate. The crux of it:
The crucial thing to understand about the offshore market is that the yuan floats freely and doesn't fluctuate within a tight band like in the onshore market, and is free of Beijing's control in that regard. This allows for different prices on a single currency and creates those arbitrage opportunities that the PBoC is now trying to squelch.

Since 2008, the yuan has weakened when foreign reserve growth slowed to near zero or declined. China created yuan far more rapidly than it took in U.S. dollars—an undervalued currency is an inflating currency. A lot of yuan are floating around with claims on a limited supply of U.S. dollars. Chinese have ways of keeping dollars offshore if they want to speculate. China's treasury holdings are more likely to be sold into a dollar bull market, instead of the other way around as many dollar doomsayers predict. Growing levels of U.S. dollar denominated debt is an outstanding bid on the dollar and put on the yuan. The big risk to China isn't yuan sellers in HK, it's dollar buyers/hoarders in China. The offshore yuan can cause trouble through its "informational power."

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