Yuan Plunges As PBOC Stands Aside

The Chinese headline calls Monday's 0.02 fen drop in the yuan a "plunge." The move was small, but for an asset that sees very little volatility, the recent move was a large one and sent the yuan to its lowest level in 4 months. Dollar shorts dried up and the central bank didn't step in to sell dollars, which led to the quick drop. Capital outflows also increased in November. In early Tuesday trading, the yuan is down another 180 pips in Hong Kong. On Monday, 1-year forward offshore yuan contracts were trading at 6.30.

China has eased its strict capital controls, but even when controls were very strict, there was an easy way for exporters to speculate on currency: leave dollar earnings offshore. Chinese have greater ability to buy and sell currencies today, and a rally in the dollar versus the yuan could be much larger than the two small bouts of yuan depreciation in 2011 and 2012.

I believe economic conditions have favored a weaker yuan at least since 2011 and I do not believe the yuan can appreciate along with the U.S. dollar if a major USD bull market begins. Weakening a currency is not a good solution to economic problems, but China controls the exchange rate. For political reasons as much as economic ones, the yuan is probably overvalued. Simply allowing convertibility would lead to a weaker yuan. If Chinese leaders want a weaker currency, all they have to do is allow greater convertibility. Previous discussions of a weaker yuan here.

Although it might shock the financial world, a slide in the renminbi to 7 versus USD in 2015 would hardly qualify as a major move in the currency markets. The yen has fallen as much in the past three months and euro is down a similar amount in 2014.

iFeng: 人民币暴跌愈两百点创四个月新低 央行未出手

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