How Far is Chinese Yuan from Argentine Peso?

The general tenor of articles on the renminbi and potential depreciation is calm. One article aiming to follow on this theme inadvertently exposes the risk in China's financial system by explaining how different the situation in China is from the one in Argentina.

JRJ.com: 韩会师:人民币距离阿根廷比索有多远?
Many media and scholars have blamed the strong depreciation of emerging market currencies represented by the Argentine peso on the recent strong US dollar market. This is certainly an objective reality, but this is only a direct cause, not the root of the problem. The instability of most emerging market currencies stems from major shortcomings in its own economic and financial system, the balance of payments structure and the foreign exchange management system. This has led to the belief that neither international investors nor natives believe that its central bank is capable of maintaining currency. The stability of the dollar is only an external trigger.
The article makes many good points about the problems in Argentina. The rising dollar was a spark, not the cause of Argentina's problems. It's main problem is it borrows heavily from abroad.
To put it simply, Argentina’s basic mode of operation of the foreign economy is to continuously borrow money to buy things. This will inevitably lead to Argentina’s lack of strong foreign exchange reserves. At the end of the first quarter of 2018, the Argentine central bank ’s international reserve assets , including foreign exchange and gold , were added together to reach a historical peak. It was only worth US$61.7 billion, which is equivalent to about a quarter of the total foreign debt.

Therefore, it is clear to the world that the Argentines themselves are very clear that Argentina’s balance of payments is very fragile and it is difficult to have other outlets apart from continuing to borrow new debt to pay off old debt. At the same time, Argentina’s capital account is basically open. Once there is a concentrated capital outflow, limited foreign exchange reserves will not be able to meet the exchange demand. There is no second way to go except for a large depreciation.

Although the Argentine Central Bank can substantially increase interest rates to attract funds and stabilize the exchange rate , ultra-high interest rates have directly deteriorated corporate operations and have a negative impact on the real economy. On the other hand, the funds attracted are often short-term speculative funds. It is almost certainly necessary to go, which further buries hidden dangers for the long-term instability of the international balance of payments. Therefore, relying on ultra-high interest rates to maintain the balance of international payments is to quench the thirst.

The long-term deficit of current account + high external debt + thin foreign exchange reserves + open capital account , the above four factors together, even if Argentina does not have serious inflation, maintaining the stability of the exchange rate in the medium to long term is also impossible. In fact, the Argentines themselves are also very clear about this, so if there is a sign of trouble in the international market, Argentines and foreign investors will also short the Argentine peso. In the face of a collective short selling by the market, the Argentine Central Bank has no effective means. The devaluation of the peso has become inevitable. However, once the peso has seen a crisis, the next time it faces international market turmoil, the market’s confidence in the central bank will converge indefinitely. At zero, there will be a collapse-type decline of "earlier than anyone else".
While an Argentine-style collapse is unlikely, this analysis misses that China's entire financial system is leveraged on its foreign currency reserves. The reserves don't exist outside of the economy as a rainy day fund, they are an integral part of the system. How much excess reserves they hold is a question that can only be answered in a time of crisis, but the ratio of M2 to reserves is already below the levels of countries at ground zero of the 1997 Asian Crisis. Even if you assume China can block currency outflows, it has to intervene in CNH to prevent information from spreading. China can't censor the free markets outside the Mainland. It also can't prevent alternative asset buying such as gold without allowing rising imports of the metal, otherwise Mainland prices will diverge from world markets and reveal the depreciation in the yuan. Markets (sometimes incorrectly) are valued on the last trade and by perception. And as I've said in the past, if you can't take yuan out of China or exchange it for foreign currency, then any rational investor, Chinese or foreign, will consider the yuan of lesser value than when it was possible to make such exchanges.
As of the end of 2017, the balance of China's full-caliber external debt was 1.71 trillion U.S. dollars, including short-term foreign debt of 1,099.9 billion U.S. dollars and medium and long-term foreign debt of 616.1 billion U.S. dollars. Foreign exchange reserves have strong guarantees for the repayment of foreign debt. This is a far cry from Argentina.
But that about the internal debt? And what happens if exports to the U.S. fall or imports rise, how does China make up the roughly $100 to $200 billion per year President Trump wants shaved off the bilateral trade deficit?
Of course, a friend may be able to say that China's current account has already experienced a deficit in the first quarter of this year, and some scholars predict that the current account deficit may become the norm. Does this not affect the stability of the RMB exchange rate?

  It is true that if China’s current account continues to suffer a deficit, for example, if there is a $20- to $30 billion deficit for four consecutive quarters this year, although the scale is not large, it will also have a significant impact on market sentiment. Because the continuous deficit may mean that the current account structure is undergoing a trend change, the stable foundation of the renminbi may be shaken. However, at present, only the data of the first quarter, whether it can become a trend is still very uncertain. The deficit of $28.2 billion in the first quarter alone is certainly not enough to incite foreign exchange reserves. Scholars can naturally point out the risks from the perspective of preventive measures, but from the perspective of the actual impact of the market, it is indeed not enough to affect the confidence of most investors.
Now about about instead of $30 billion it is $100 billion?
The author had previously proposed that even if the US dollar index reaches 95, the bilateral exchange rate of RMB against the US dollar can reach 6.45, which is still the current limit. In the case of a stronger US dollar, the renminbi will depreciate against the US dollar, but the magnitude of the devaluation will be much smaller than other currencies. The overall exchange rate of the renminbi against a basket of currencies will even rise in the basic stability. Therefore, the renminbi has no risk of currency crisis. What we need to worry about is whether the renminbi will be too strong against a basket of currencies and whether it will have a negative impact on export competitiveness.
What about DXY 100? 110? 120? The analysis isn't wrong, but it only holds within a low volatility environment. Increase the stress and the logic cracks.

With consolidated political power, Xi Jinping could afford a larger slowdown and credit deflation as a consequence of maintaining the yuan's value relative to most currencies amid a dollar rally. It would be a long-term positive for the country, but in the short-term it only shifts the burden from the currency to real estate, equities and corporate debt prices, along with slower economic growth and higher unemployment.

China is not at risk of an Argentine-style currency collapse, but back in August 2015, the PBoC allowed the yuan to drop a small amount. It was surprising only because the yuan's daily fluctuations were tightly controlled until then. Still, the move caused global panic. There is complacency again and few expect a resumption of yuan depreciation, the flipside being they also don't expect much dollar appreciation. What if they're wrong?

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