Why the chinese Yuan is overvalued

The excellent Epsilon Theory blog has an interesting essay on how the rules of the game are changing in China: essentially it slowly dawns on Chinese leaders that the successful growth model of the past decades, where a stable or even steadily increasing currency has been one of the main pillars, is not sustainable in a world in which its main trading partners are trying to keep the status-quo (“stability”) by means of credit expansion and beggar-thy-neighbour policies. To sum it up: Fed QE has probably done most harm in China.  Unexpected, eh? The Chart below neatly illustrates how things have changed.


The blue line shows the CNY/USD exchange rate which has been slowly appreciating over the past ten years. The first big appreciation period (2004-2008) was accompanied by healthy gdp growth (green) and relative outperformance of Chinese stocks relative to their US counterparts (red). The Chinese authorities, like everyone else, were surprised by the financial crisis: growth slowed down markedly and they decided to briefly suspended their CNY appreciation so as not to weaken domestic importers unnecessarily. Eventually markets calmed down due to central bank intervention in the West (and heavy credit growth in china) and the bureaucrats continued their steady appreciation policy as if nothing has changed. But things have changed: as the chart shows, growth has come down markedly and Chinese shares have lost substantial ground compared to their us counterparts…have Chinese leaders finally realized that the game has changed? Is this what their recent, timid devaluation efforts are about?

As readers of this blog know I think that China is the biggest credit bubble in recorded history. Whether they realize the game has changed or not: ultimately they will have to devalue the CNY – with worldwide repercussions, compared to which the 1997 Asian crisis will look like child’s play…




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