Yuan Internationalisation and Bitcoin

On October 1st of this year, the IMF added the Chinese Yuan (CNY) to the Special Drawing Rights (SDR) basket of currencies. Only Big Boy currencies are included, and now China is part of the club. USD, GBP, JPY, EUR, and now CNY make up the basket.

The IMF could not ignore the currency of the world’s second largest economy. In order to be considered, China pledged to speed up the internationalisation of the CNY. That meant gradually opening up its capital account, and allowing the market to determine the value of the CNY.

China isn’t one to follow diktats of foreign countries to the letter. Beijing believes the addition of the CNY to this basket is a symbolic step towards legitimising their economy, and the methods by which they manage it.

The question now is whether China will play ball given that it is in the club. The Yuan has depreciated over 7% in the past 12 months. Everyone agrees that the Yuan will need to weaken. The question is the pace and eventual magnitude of depreciation.

China is addicted to credit fueled growth. Beijing recognises the problem, but credit growth continues. Someone will need to bear the losses. It will either be the heavy industry, or the household sector. The problem for Beijing is that the heavy industry sector is politically powerful, and more importantly employs millions of workers. Social unrest will not be tolerated. The number one goal of the Communist Party of China is to remain in power. As such, state owned banks are still directing loans to zombie state owned industrial companies and the property sector.

China cannot continue to print money and defend the Yuan from massive depreciation at the same time. Companies and individuals are fleeing the coming domestic inflation by exporting their capital abroad. I argue that in the absence of the IMF SDR review period and inclusion, China would have depreciated the Yuan much more already. China would have lost “Face” internationally if they sliced the Yuan by 30%, while at the same time applying to be a global reserve currency. If you have lived in this part of the world long enough, you know that losing “Face” outwardly is to be avoided at all costs.

Those who look to official figures of FX reserves as evidence that capital outflow is waning are being fooled. Chinese companies continue to do massive M&A deals globally. Chinese citizens continue to levitate luxury property markets across the globe. Vancouver recently implemented a 15% foreigner property tax to deter the ravenous Chinese.

Now that China has officially joined the club. They are free to monkey hammer their currency lower just like the Fed, ECB, BOJ, and BOE do, and not lose “Face” doing it. Quantitative easing is just a fancy name for money printing. Western central bankers are masters at it, and now China will openly play the game as well.

Traders will be watching the PBOC’s 9:15am reference rate closely. The PBOC’s actions in the first week after the inclusion will help frame expectations for future actions. Now that Fed rate hike odds for November and December are rising, I expect the PBOC to come out guns blazing. A year end USDCNY rate of 7.00 is definitely in the cards.

Don’t forget about Europe. One or more banks might meet the reaper in Q4. The PBOC will need to inject more money to mitigate any contagion risk spreading to Chinese financial markets. The Golden Week calm is a chimera. Next week the fun begins again.

The trend is clear. CNY down, Bitcoin up. If the PBOC begins Q4 by slicing the Yuan, Bitcoin will be jolted from the doldrums. The path to $1,000 will be paved with depreciating Renminbi.