Political Ambition Will Strangle Economy

Balding: China’s Currency and Debt Problem

In closing, let me note just how invested China is in maintaining the status quo. In a rapidly slowing economy with producer price deflation, the most direct method of driving the economy would be lowering interest rates. However, the PBOC can’t even entertain significant cuts because of the pressure to the RMB, capital outflows, and knock on effect of liquidity reductions in the credit market. In short, Beijing is willing to strangle its own economy to meet its political objectives of maintaining the peg and joining the SDR.

China can try a third way: take actions that devalue the currency, but intervene to prop up the market. Yuan devaluation is still not a mainstream position and with enough jawboning and timely announcements (we found another 2,000 tons of gold!), they might levitate the yuan for a time. With the next phase of a U.S. dollar rally seemingly weeks away though, the squeeze is about to be put on the Chinese economy if the yuan rises with it. The already struggling resource and heavy industry reliant provinces will be in even worse shape than they already are, emerging market commodity exporters will suffer and it will rebound back as lower exports.

Emerging market currencies depreciated about 4% versus the yuan in July.