Market Expectation Will Continue to Drive the Yuan Downward

China has been burning through its currency reserves in order to support the Yuan. The experiences of Russia and Brazil tell us that market expectation will continue to drive the Yuan downward and that China should hold on to its currency reserves as its currency falls. Bloomberg discusses why China should stop burning up its currency reserves.

China has wiped out about a quarter of the world’s heftiest foreign-currency stockpile over the past 18 months in its quest to keep the yuan stable. According to Commerzbank AG, such intervention is futile.

Data Tuesday showed China’s foreign reserves slipped below $3 trillion in January, the first time they’ve breached that psychologically potent level in almost six years. Yet the experiences of some fellow BRICs show that drawing down the stockpile will probably have little effect on the currency’s long-term fate, Hao Zhou, Commerzbank’s Singapore-based senior emerging-markets economist, wrote in a research note late Tuesday.

The authors point to Russia and Brazil of examples of how Forex fundamentals and the market will eventually have their way.

While efforts by Russia and Brazil in recent years might have cushioned the blow of currency declines, they couldn’t change the market’s dynamics. In Russia’s case, a collapse in oil prices and the imposition of economic sanctions over the Crimea crisis proved more powerful drivers than the sale of a third of the country’s foreign-currency hoard between April 2013 and March 2015. The ruble fell more than 50 percent versus the dollar in the period.

Brazil at least used currency swaps instead of spending down its reserves. Where is the stopping point for the Yuan and if China does not change its policy where is the stopping point for Chinese currency reserves?

How Far Will the Yuan Fall?

If we believe that market expectation will continue to drive the Yuan downward how far will it fall? Reuters says that there is more Yuan fall and capital outflows in the next year.

The yuan could fall by five percent in 2017, and anything more than that will result in greater capital outflows, former People’s Bank of China (PBOC) adviser Li Daokui said.

The PBOC could spend an additional $200 billion to $300 billion to achieve its goal to control currency moves, Li, who now teaches at the Tsinghua University, told the Reuters Global Markets Forum on the sidelines of the World Economic Forum.

Li also said he expected growth to be the top priority for the Chinese government, over reforms, this year.

The author’s belief is that China will spend reserves to protect the Yuan from falling more than 5% during 2017. The problem for China is that the market will have its way and spending reserves will not turn the Yuan around on a permanent basis. That will require systemic changes in how China’s economy operates. And in the land of managed capitalism, where Communist leaders had grandparents who were on the long march and were cronies of Chairman Mao, that will be hard. First and foremost the Chinese leadership wants to stay in power and if that means spending all of their currency reserves, so be it.