Analyst Says Yuan Devaluation Could Trigger Losses of 30% to 50% in FX Markets, How About the Yuan?

Bloomberg: Currency Rout Goes Global as Jen Sees Risk of 50% Loss on China

Its devaluation of the yuan risks a new round of competitive easing that may send currencies from Brazil's real to Indonesia's rupiah tumbling by an average 30 percent to 50 percent in the next nine months, according to investor and former International Monetary Fund economist Stephen Jen.

Back in 2013 I wrote: Chinese Yuan Could Devalue 50% Or More and did a back of the envelope calculation on whether the yuan was over or undervalued.

Chinese Inflation

Back when the Chinese yuan was pegged at 8.28 to a U.S. dollar, whenever a U.S. dollar entered the Chinese financial system, it was exchanged by the People's Bank of China (PBOC) for 8.28 renminbi. Most economists and analysts believed the yuan was undervalued at the time, but there was a lot of disagreement about how much it was undervalued. At best, I can say that had the peg had been maintained, eventually the real value of the Chinese yuan would reach that exchange rate of 8.28 to $1 and even move lower thanks to galloping inflation.

So was the yuan over or undervalued before it began rising in 2005? Almost everyone said it was undervalued, but what was the real value? At the time there were many numbers bandied about, many were in the range of 20-40% undervalued. Say it was 30% in 2005, just as the yuan was allowed to float. That means the real value of the yuan in 2005 was about 5.8 to 1, when the yuan began to rise from 8.28 to $1. At 6.1 yuan to 1 dollar the currency is still weaker (versus the U.S. dollar) than it was in real terms in 2005, and yet the Chinese central bank and government have stated in the past year that the yuan is "fairly valued." (03/12/2012 China's yuan nearing fair value: PBOC's Zhou ) Therefore, in real terms, depending on your initial value for the yuan, it may actually have fallen in real value since 2005 or been flat relative to the U.S. dollar.

So has the yuan been appreciating or depreciating in real terms? The central bank still maintains a dirty peg: it allows the yuan to trade in a band around a price set by the central bank. While the market is increasingly allowed to set the value within the band, it is only allowed to do so within the confines of the central bank policy and China clearly had political reasons to allow the renminbi to rise versus the U.S. dollar. By 2008 there was a growing risk of trade retaliation by the United States, in 2012 it was a topic of the Presidential campaign and in 2013 the EU is implementing anti-dumping tariffs on Chinese solar panels, with calls for more tariffs on Chinese goods. Since China's leaders can more easily exchange between political and economic costs, we should be open to the possibility that the yuan has a far larger political component to its value than other currencies.

Much of the time reserves don't matter until they do, at which point they become the most important thing. If reserves matter to any degree, the yuan stopped appreciating in real terms around 2008. Money supply growth has been as fast, or faster, than reserve accumulations since 2008, and much faster since 2011.