Wednesday, January 6, 2016

China: Even After Today's Action the Yuan Is Still Overvalued

As noted by the Financial Times, January 7, 2016 2:37 am:
...Stocks plunged, for the second times this week, after the renminbi saw its biggest one-day weakening since China’s surprise devaluation last August. Currency concerns have spooked China’s markets which have gone into a replay of last summer’s meltdown and left policymakers struggling to contain the fallout.

On Wednesday, the People’s Bank of China fixed the midpoint — the level around which it permits the onshore currency to trade 2 per cent — at Rmb6.5646, 0.51 per cent weaker than Wednesday and its biggest one-day weakening since China’s surprise devaluation in August first alerted investors to renminbi risk....
Here's SafeHaven earlier today:

Another 2% Yuan Devaluation Coming Up? What Are the Risks? Explaining Chinese Capital Flight
Another Yuan Devaluation Coming Up?
Currency trends suggest another yuan devaluation is coming up. Specifically, the gap between the mainland China yuan (renminbi) to the US dollar, vs. the offshore floating rate of the yuan to the US dollar is now at a record high.

The reason there are two rates is China has tight controls on the range the yuan trades in China, but the yuan floats outside China.

In contrast to previous years where traders bet the value of the yuan would rise vs. the US dollar, traders are increasingly betting China will devalue.

Explaining Chinese Capital Flight If China had no capital controls, the onshore and offshore rates would have to be identical otherwise there would be an instant guaranteed free money arbitrage opportunity in virtually unlimited size were China to maintain a peg the market did not agree with.

Here are a couple of charts that show what I mean....

...Onshore / Offshore Rate Differentials
  • The onshore rate is 6.5567 per US dollar.
  • The offshore rate is 6.6993 per US dollar.
Another 2% Devaluation? The onshore yuan is weaker than offshore by 0.1426. That a bit over 2%.

In the absence of capital controls one could make an instantaneous 2% on an unlimited amount of money. That such spreads exist shows that capital controls work, for the most part, at least for now.
However, capital controls are not perfect. Those able to skirt capital controls do so. One possible method of free arbitrage would be export/import trades that do not really take place, or simply padded higher.

Fraud of such nature cannot be unlimited. $1 trillion in sudden exports or imports is going to get caught, but smaller amounts can be hidden.

In addition, those sitting with a lot of money in a depreciating currency don't exactly like that outcome. Thus capital flight pressure is intense for two reasons.

One way or another (slowly over time, or by another 2% devaluation), the yuan appears destined to sink. When will it stop?...MORE
Earlier today:
China Stock Markets Shut Down For The Day On 7% Decline

See also FT Alphaville's primer and prequel: 
The consequences of China’s new circuit breaker
New year, new Chinese circuit breaker