Is USD/CNY's Steady Climb a Boon or Serious Risk for China?
- USD/CNH has risen to fresh record highs while the longer-running USD/CNY tops six-year highs
- A depreciation of the Chinese currency does help the countries exports and thereby GDP
- Yet, a serious risk arises in promoting/allowing the exchange rate to rise should risk aversion kick in
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The standard view from the growing protectionist/anti-globalization crowd is that a falling Yuan is a suspicious advantage that Chinese officials are somehow encouraging. It is true that in a simple trade system, a cheaper currency is a boon for the country with the cheaper currency - its goods are perceived as 'more affordable' to its partners. And, China's rapid expansion and export manufacturing dependency these past decades has reflected a country that has certainly taken advantage of the technique. However, traders and Chinese authorities should question the fading benefits that supposed manipulating would confer against the dramatically greater risk it carries.
Ever since the People's Bank of China announced a change in the valuation method of the Chinese currency on August 11, 2015, there has been a general trend higher for the USD/CNY (onshore) and USD/CNH (offshore) rates. While some believe this was a different approach at manipulation compared to the fixed regime that preceded it, this likely does represent a 'truer' reflection of how the exchange rate would move in a free exchange rate. Alongside the more flexible rate have come opening doors for capital flow into and out of the country. And, in the cycle we currently find ourselves; the desperate reach for yield has tempered. That means, the China boom appeal has also cooled. In turn, global investors that rode the dragon can now repatriate their profits and capital.
It is not a coincidence that the most abrupt rallies from USD/CNH have accompanied tumbles from the more traditional risk benchmarks (S&P 500, Emerging Market ETFs, etc). In a flight to quality, it makes sense that the speculative capital in China would leave to havens like the US. What modest advantage the weakened Yuan may confer the Chinese export sector is dampened by the fading global demand and more uncertain financial system. With risk trends holding steady, the rise in USD/CNH presents an even greater risk. If capital is moving out of China during these steady / slightly-risk-on conditions, it suggests there is a natural flight of funds. In the event of risk aversion, we already know the mechanics of these capital flows: investors will accelerate a deleveraging and drive the pair higher. Not only will that require moves by the PBoC and SAFE to stabilize with capital controls and exchange rate actions, it will send a clear signal to increasingly unstable backdrop. China is a risky investment should global sentiment sour.
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