Flexible Yuan Goes Down, Not Up

Compare these two parts of the article:

China Warms to a More Flexible Yuan

The shift comes as the People’s Bank of China grapples with what some within the central bank call “unprecedented” downward pressure on the yuan, thanks to a strengthening U.S. dollar and a slowing Chinese economy. The yuan has fallen more than 2% against the dollar since the beginning of this year, putting it on track for its first annual decline in five years. On Wednesday, it was down 2.3% against the dollar for the year.

But the PBOC is unlikely to permit the yuan to slide more than 3% against the dollar, the officials and advisers to the central bank say. Big yuan depreciation could cause money to flow out of the country just when China needs funds to spur economic growth.

The yuan is down 2.3% this year and a decline of more than 3% will cause capital outflows.

Jim Rickards has described a change in the market as a "phase transition." It is a jump from one equilibrium to a new equilibrium. Today, people believe the yuan is a stable currency with a bias towards appreciation. They expect very little volatility, and almost none on the downside.

The PBOC and China generally have the illusion of control because of their past success. Even the most competent can lose control by believing they control the market. China's leaders appear competent because they are willing to cede control of the economy to the market as it grows in size and complexity. If Chinese leaders suffer from the Fatal Conceit, the yuan will fall. If they open the economy, the yuan is a better bet, but it could also fall due to volatility in the market. The risk today is on the downside, and if its cheap to bet on a move outside of expectations in 2015, I'd take it.