It’s now been about 10 months since I last wrote about the Chinese Renminbi (CNY). At the time, I was bearish and expecting a decline in the CNY (which has since happened).
Now here’s the thing about devaluations; when the structural forces say that a controlled currency should devalue—it usually does. It’s rare to see a “one and done,” especially when the currency is only allowed to devalue by a few percent—as it did in August.
To review why the CNY should go lower;
-With the decline in commodity prices, China no longer needs a strong currency to pay for the importation of raw commodities, which removes the only real reason to have a strong currency
-China is an export economy and the currencies of many of its trading partners have declined dramatically. Looking at a list of major world currencies, they all have declined by 10% to 30% against the dollar in the past year. The CNY is the only notable outlier as it is only down 2.5% during this time
-The Chinese economy is clearly slowing following a massive misallocation of capital complete with a huge credit bubble which is now unwinding
-The Chinese need to stimulate their economy and the easiest way to do that is to have a much weaker currency
When a government chooses to fight against devaluation, the timing of the trade is made more difficult—however the first baby-devaluation shows that the direction is no longer towards a stronger CNY. History has repeatedly shown that once a currency changes direction, it usually goes much further than just a few percent. With China going through nearly 3% of its foreign reserves in August alone, clearly we’re entering a crescendo where the reserves will shrink faster and faster as locals realize that a larger devaluation is coming.
For me, following a bit of a pull-back over the past two weeks, it now seems like “game time” for the CNY. While the timing of a much larger move is unsure, it is clear that the direction has changed and the next move is likely to be a much larger and sustained devaluation. Additionally, I’m quite bearish on the world economy and this trade seems like one of the best risk rewards out there to play a slowdown in China and hence the global economy. You can play through cash currency or OTC options where volatility still prices cheaply. This trade definitely feels like shorting the Japanese Yen a few years ago and we now appear to be at the inflection point where things start to accelerate rapidly.
Put it this way–if the CNY was approximately fairly valued, the Chinese wouldn’t have spent almost US $100 billion in August to defend their currency from further depreciation… (to be continued)
Disclosure: I’m short Chinese Renminbi.