The Yuan Illusion

One of these things can't be true.

Global Times: Market plays decisive role in exchange rate: Yi Gang

"China will continue to let the market play a decisive role in the formation of the RMB exchange rate," Yi said in the statement. "We will not engage in competitive devaluation, and will not use the exchange rate as a tool to deal with trade frictions."

...China's central bank governor Yi Gang on Saturday promised to keep the yuan currency's value "broadly stable" at International Monetary Fund and World Bank annual meetings in Bali, Indonesia, where the IMF attempted to prod the world's two largest economies to resolve their disputes.

It's true that China will not devalue the yuan to boost exports. It's also true that China can't boost liquidity in China without growing yuan supply amid quantitative tightening and rising interest rates in the United States. If push comes to shove, Chinese monetary policy will zig while the U.S. zags. The divergence is showing up as stress on the exchange rate. China is absolutely not letting the market set the exchange rate and it has draconian capital controls in place to make sure Chinese mainland investors can't participate in the market.

The market is allowed to operate between USDCNY 6.20 and 6.90. Below 6.20 and exporters scream. Above 6.90 and depreciation expectations start building. However, if the euro or yen also weaken, a falling yuan will be "broadly stable" as it devalues versus the U.S. dollar along with everything else.

The dollar bulls will take USDCNY past 7.0. It will take out major psychological barriers without raising alarm. Then we'll find out if capital controls are as tight as they seem.