Currency Devaluation Fears Come to China: USDCNY 19.77 Goes Viral

Most fake news stories online represent either a real, factually-based counter-narrative (i.e. something truthful) or it is purely a counter-narrative. I occasionally do posts on suspected rumors out of China because, despite the likelihood they're false, the very fact that they went viral is a sign of something underneath, a fear or belief that causes a "Fake news" story to be readily accepted.

Chinese authorities are now dealing with a viral story whipping through Chinese social media: CNY should devalue 65 percent, to USDCNY to 19.77. The forecast isn't solid, but the fear of Chinese citizens is now exposed to the world and explains why draconion capital controls are in place.

SCMP: US$1 for 19.77 yuan? How a bogus social media rumour reveals fear that China is printing money

The theory surfaced in a number of social media accounts as long ago as June, but has been spreading rapidly since September after appearing on Zhihu, a Quora-style question-and-answer website, and Tianya.cn, an online bulletin board.

According to the theory, the fair exchange rate between the yuan and the dollar can be calculated solely using the respective GDP and total money supply of China and the United States.

The US had a GDP of US$19.36 trillion in 2017 and money supply, or M2, of US$13.92 trillion, resulting in a M2/GDP ratio of 0.719. Applying the same ratio, China’s US$12.24 trillion economy should have had US$8.8 trillion of money supply at the end of 2017. Instead, China’s actual money supply was 174 trillion yuan (about US$26 trillion at the current exchange rate), meaning – going by the M2/GDP formula – the actual value of a US dollar should be 19.77 yuan.

Here's one site posting this theory back in June: 1美元等于19.77元人民币？！ It compares the money supply (red) sand GDP (green) of the US and China, along with the UK, EU and Japan.

This story is going viral and a former official from SAFE stepped in to refute it:

While this argument has fundamental flaws – such as assuming the US and China should have the same M2/GDP ratio – its simplicity has helped it to gain popularity on Chinese social media platforms including WeChat and Weibo, and stirred debates involving reputable economists.

Guan Tao, who works for a think tank and is a former senior official with China’s State Administration of Foreign Exchange, which is in charge of China’s foreign exchange policies, wrote an opinion piece in the Securities Times newspaper last week to dismiss the theory as sensationalist and without academic or empirical foundation.

“This theory is just another form of the argument that China has printed money excessively and the yuan is set to devalue,” Guan wrote.

The officials doth protest too much. A very easy way to bury a story is to ignore it. That's how governments and established powers keep a topic off the table. Now that there's an "official" response to this viral story, there's an opening for more plausible currency valuation theories. Instead of putting the issue to bed, authorities have opened themselves up to a game of whack-a-mole. And if they decide to censor new currency depreciation theories, that will tell the public the government believes it.

However, Zhao admitted the fear about excessive money printing in China was real.

“It shows that people are worried the central bank has pumped too much money into the economy … and shows panic and fear about the yuan’s exchange rate,” he said.

Professional foreign exchange traders are expecting modest yuan depreciation but few are forecasting it to tumble like Argentina’s peso or the Turkish lira.

Price controls are also coming back to bite Beijing:

At the same time, Zhao said Beijing’s rigid control over the exchange rate had instilled mistrust in the official prices, enabling outlandish theories and wild guesses to flourish.

“One of China’s problems is that the yuan was not allowed to float freely,” he said.

It's why CNH is the real exchange rate and why China is open to speculative attack on the yuan. China must prevent CNH from falling, and from CNY diverging from CNH, because CNH is the real price. See: The Informational Power of the Offshore Yuan Exchange Rate

When the market is operating under normal conditions, everything seems to indicate yuan strength and China has tight controls on inflows to slow yuan appreciation. But if the market is not normal— if there are no bidders for yuan, but instead a growing demand to hold dollars both onshore and offshore— the offshore yuan is free to tumble. And if CNH tumbles and the financial system sees a dollar shortage, the PBOC has to follow CNH lower to bid the dollars back or it has to spend its dollars (or let them be spent by banks and citizens) to halt the decline in CNH.

Depreciation fears are bottled up by capital controls, but Chinese can sell yuan for other assets. With stocks and real estate looking unattractive here, gold could step into the role of safe haven asset if it can establish a bullish price trend in CNY (or even better, CNH).

Here's Guan Tao's article: “1美元=19.77元”？这个判断不靠谱
His defense of the yuan doesn't exactly inspire confidence:

Third, although China's M2/GDP is much higher than the US, it does not mean that the RMB exchange rate against the US dollar is necessarily overestimated. Because, first of all, the difference between China and the United States is not much different, both around 2%. There is no high inflation in China that seriously erodes the purchasing power of the renminbi. Secondly, after years of loose monetary environment, both China and the United States have different levels of asset bubbles. China's housing market, the US stock market, and Japan's bond market are also called the world's three hardest bubbles. Again, the US and China's non-financial sector leverage is not low, only China's non-financial companies add leverage, while the US is The government department has added leverage, and the family has a difficult experience. Although the US government's tax reform measures centered on tax cuts have boosted US economic growth in the short term, the sustainability of medium- and long-term US government debt is even more worrying.

What happens to the yuan, dollar and yen if all three of these bubbles implode? Collapse, soar, collapse.

His final paragraph also raises questions about the yuan's exchange value:

Fifth, foreign exchange trading is not the main business of most domestic market players. Therefore, it is advisable to grasp the general trend in the trend of RMB exchange rate. The fundamental factors in determining the trend of the medium and long-term exchange rate are: economic stability, stable currency, strong economy and strong currency. The reason why the short-selling and short-selling renminbi in the past two decades has been defeated is that these people have neglected the strong renminbi foundation laid by China’s 9% to 10% annual economic growth, and were short-term impacted by the Asian financial crisis and the global financial tsunami.

Two of the four pillars are gone. China's economy is not as strong as it was and it does not have a strong currency, evidenced by draconian capital controls propping it up. Stability is an illusion created by authoritarian price setting in the market, intervention to prevent visible weakness (such as defaults) or extremely limited access to global forex markets.

The market is aligned for a phase transition. USDCNY 9 is probably as absurd as 20 to many market participants. The Chinese government "won't allow it" is something believed with respect to defaults, recession and currency depreciation. In August 2015, the Chinese government allowed the currency to depreciate by an amount similar to a volatile week for the euro. Global financial markets panicked. While markets have adjusted to slightly more volatility and a yuan that moves inversely to the U.S. dollar, yuan-specific depreciation is an outlier view among China bears. But they now have a powerful group who is receptive to their bearish yuan arguments: the Chinese public.