This will be the final part of three with regards to the yuan being overvalued and its impact on bitcoin. The other two can be found here and here. As has been mentioned, many experts are coming out and saying the renminbi needs to devalue further, with some experts seeing a gradual loosening all the way to the other side of the spectrum of a complete "unpegging" from the band with the USD. Regardless, if this loosening begins to accelerate it will be bullish for bitcoin. Let's assume based on a piece that came out today, that the yuan is overvalued by 20%. It has already gone up in price by 3% to 6.50. Another 17% from that level puts it at 7.60, as the chart below shows.
China's hand is being forced by an extraordinarily weak economy and a persistently strong USD. This has led to the entire emerging market and commodity complex getting crushed. If China continues to devalue this will only exacerbate the situation, especially if the USD remains strong. The chart below shows that commodities have broken major support and are sitting at 20 year lows.
The toxic mix of USD strength, commodities getting crushed and emerging market local debt denominated in USD has been talked about in another blog post I wrote. Brazil was used as the textbook example for this. They also happen to be one of the countries with the highest uptake of bitcoin as well.
Defending the Yuan Peg
In order to defend the peg, China has been emptying its FX reserves, at a time when according to a Royal Bank of Australia (RBA) report, capital outflows have reached record levels.
"China has been a net recipient of large amounts of foreign private capital over the past two decades......These trends in capital flows reversed last year. Between early 2014 and mid 2015, around US$450billion of private capital flowed out of China in net terms and the PBC reported selling or letting mature US$75 billion of its foreign exchange reserves as private capital outflows began to exceed the country’s current account surplus. The move towards private capital outflows and reserve sales accelerated sharply in August following the PBC’s decision to allow the US dollar-RMB fixing rate to become more market determined. While official data are not yet available, partial data suggest that private capital outflows increased to around US$300 billion in the September quarter (10 per cent of GDP) and that the PBC sold or let mature a further US$200 billion of its reserves."
Below is a graph showing this trend and simply put it has become extremely expensive and now unattainable for China to keep a tight peg. Loosening is the only way forward. Not only will it relieve pressure from the relentless selling off of FX reserves and US government bonds but its a form of monetary stimulus. Ambrose-Pritchard points out that:
"Defending the currency on this scale is costly. Reserve depletion entails monetary tightening, neutralizing stimulus from the cuts in the reserve requirement ratio (RRR). It makes a soft landing that much harder to pull off."
As has been mentioned in other blog posts this has led China to instill capital controls in an effort to stem the bleeding. They have not worked as well as hoped and Chinese have found creative ways to get money offshore. Bitcoin has been one of the major beneficiaries and will continue to be especially if the the devaluation takes even 10%-20% higher. This will continue to erode purchasing parity onshore and we may see the spread between onshore and offshore yuan continue to blow out from its current levels shown below.
With Mauricio Macri, the new president of Argentina coming into power today, expect major reforms to happen. Argentina's economy has suffered greatly in recent years and it has one of the highest inflation rates in the western world at a little under 20%. Capital controls have been in place for a while and buying US Dollars has been restricted.
Macri has promised to lift these restrictions on the USD. Argentina LocalBitcoin volume has been growing as a result of a tightening of these capital controls throughout 2015. Exchange volume has been up as well.
If these restrictions are lifted and other economic reforms begin to occur expect a devaluation of the peso. This may lead to higher upticks in bitcoin buying and certainly in USD buying as a hedge.
Devaluations, Capital Controls, Strong USD
It hasn't just been the rise of the USD that has been problematic, but the velocity with which it has risen in a rather short time. On top of this, it has stayed at elevated levels without respite. This has led to global consequences which are only starting to be felt. As countries are forced to adjust their economies and currencies to the new environment and purchasing power continues to be lost, alternatives will be sought to evade capital controls and devaluation.