2015-12-09

More Yuan Depreciation Talk as Models Get Reflexive

Bloomberg: A Strong Dollar Hurts China More Than the U.S.
The biggest loser from a stronger dollar may be China, not the U.S. And that’s why some economists predict the Asian nation will loosen its currency’s link to the greenback and allow the yuan to depreciate.
Where were they a couple of years ago? Few if any were predicting this turn of events. I don't point that out to show they were mistaken then, but to highlight that they're probably still mistaken today, in terms of the coming magnitude of change.
A sudden 10 percent rise in the dollar slows Chinese economic growth by almost one percentage point, nearly double the impact on the U.S., according to computer simulations run by economists at Goldman Sachs Group Inc. in New York.

“China is more open to trade,” Goldman chief economist Jan Hatzius said in an e-mail. “So the same exchange-rate move results in a bigger GDP effect.”
The Eye of Soros turns to the Chinese yuan, and the voice said, "Reflexivity!"
Reflexivity asserts that prices do in fact influence the fundamentals and that these newly influenced set of fundamentals then proceed to change expectations, thus influencing prices; the process continues in a self-reinforcing pattern. Because the pattern is self-reinforcing, markets tend towards disequilibrium. Sooner or later they reach a point where the sentiment is reversed and negative expectations become self-reinforcing in the downward direction, thereby explaining the familiar pattern of boom and bust cycles
The next section at the wiki entry is quite timely, it references this article: China is Not Collapsing. In it, Anatole Kaletsky discusses why Western analysts are wrong to expect a collapse. He seems to only be addressing the Johnny-come-lately China bears though.

China's credit boom is a classic case of what Soros calls reflexivity (Austrians and Steve Keen make different arguments, all addressing similar issues with debt). Another fundamental is currency, which I've been discussing here for some time. If Goldman's model is in the ballpark, a further 10% rally in USD without RMB depreciation will cause Chinese GDP to slow by ~1%, which will cause people to turn more negative on China and likely increase currency outflows and depreciation expectations, which would help fuel a USD rally and then more economic weakness in China, a reflexive relationship that will terminate after the USDCNY overshoots its mark.

As I put it a couple of years ago:
Is the yuan going to fall 50%? When thinking about the non-linear effects of the financial markets, it isn't impossible. Much of the global economy and financial markets are all positioned for a rising yuan. Psychologically, the world is expecting a rising yuan. The odds of a crisis remain low, but if one begins, it will be large because most investors are on the other side of the trade. If China experiences a crisis, it will not be contained, but be far more volatile precisely because the economy and currency have been sheltered from market forces. Even without a major crisis, the pressure on the yuan will push it towards devaluation against the U.S. dollar in the future, not appreciation. That said, if analysts already think the yuan could be 30% overvalued, a decline to 50% would not be out of the cards.

If the Chinese economy experienced a major recession and currency devaluation, the U.S. dollar would be the main beneficiary globally, as devaluations spread across most emerging markets. This could be happening now with Brazil, India and Australia among the nations experiencing currency depreciation versus the U.S. dollar (and Chinese yuan).
One Chinese bank has called for as many as three 15% one-off devaluations. Fundamentals and sentiment have favored the bears for several years, and now the time when reflexivity will really start kicking in. The shift from bullish to bearish on the yuan is a huge sentiment move, but most economists are still predicting small moves. Very unlikely given the history of financial markets.

No comments:

Post a Comment