Some analysts are starting to wake up to the risk and price it into the models, with a substantial devaluation in the yuan now on the table solely due to political risk. One of the main currency risks I've cited in the past is political. China had a window to appreciate the yuan, but waited far too long. Then within a couple years of appreciating the currency, it re-pegged in 2008 during the financial crisis to prevent a yuan collapse. Then it restarted a slow appreciation in 2010, but by 2011 there were already cracks appearing, and by 2014 forex reserves peaked. The currency was on its way to weakening as the U.S. dollar began a major rally and political risk was rapidly rising due to an ongoing depression in the developed economies. Now China is caught in the middle of a roaring dollar bull market and very negative political risk. It has no good options, save for a major win-win trade negotiation with the United States.
SCMP: Be careful what you wish for Mr President, a stumble in relations could send China’s currency for a tumble
But “if the US were to engage in, or credibly threaten, trade restrictions on China, the probability of a free-floating renminbi in 2017 could be as high as 50 per cent,” SocGen said.What if yuan devaluation is a feature not a bug? As with the 2016 election, many supposed experts are using broken models to predict world events. If Trump can get China to devalue the currency by 20 percent, he has a slam dunk case (with the American people) when he proposes a 35 percent tariff on Chinese goods. If under a Trump administration, trade is a tool for national security, then it becomes even more likely a trade war is desired, rather than feared, because a drop in global trade sets back China's military modernization and expansion. The Logic of Strategy: Yuan Devaluation and the Road to Trade War
The yuan would in all likelihood then plummet in value.
“Given that China has a reasonably strong external position (current account and net international investment positions), a free-floating regime is unlikely to cause the renminbi to fall more than 20 per cent from current levels,” the French bank concluded.
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Back in 2012: China Daily agrees: the yuan can go down
There's a vocal chorus of people who assume that anytime China (or anyone for that matter) sells U.S. dollars, it is bad for the greenback and signals an end to the U.S. dollar's status as reserve currency. This is muddled thinking however, since it very much matters whether one sells from a position of strength or weakness. Thailand, Malaysia, South Korea and Argentina before them spent their foreign reserves trying to defend their currencies and no one thought that was bearish for the U.S. dollar, in fact it was extremely bullish. China's situation is different today. The most likely reason for them to support the currency is political—they want to avoid a trade war with the United States and Europe—but should the economy weaken or another global financial crisis erupt, they may be forced to defend the currency. Either way, the renminbi is much weaker today than it is popularly perceived to be and at risk, in the event of a "surprise" contagion, of a swift decline.If you don't have political risk in your model, adjust your yuan targets to the downside.