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Let's do a currency economics thread. Let's start asking whether a falling RMB is good or bad for China? I'm an economist so it depends. If taken strictly in the light of US-China trade. It's a good thing. Chinese exports are cheaper that is good for China. However... 1/n
This has a couple of very clear consequences. First, US retaliation which we have already seen. (In fairness to China they are manipulating it upwards and the devaluation in percentage terms was effectively irrelevant though the intent was clear). Second, it raises cost of 2/n
of international borrowing. China has little foreign debt relative to the economy or borrowing. However, large borrowing relative to FX reserves and large in absolute terms. I believe external debt is roughly 65-70% of FX reserves and short term debt is 45% of FX reserves 3/n
That means that every time the RMB declines, it makes that foreign denominated debt that much more expensive. This is also why they are unlikely to let the RMB drop much. So when we talk about whether the RMB falling is good or bad for China, we need to look at what is the 4/n
Difference between additional exports from a lower currency vs. higher debt costs from lower RMB. To put this in perspective, I believe China did like $500-600b in exports to the US last year but has $2.2 trillion in external debt with most of that short term. This implies 5/n
They are going to pay a lot more on debt service cost to boost exports just a little in relative terms assuming Trump doesn't do something like raise tariffs to 25%. The key point is this: when you consider whether a falling RMB is good or bad for China, you need consider the 6/n
Tradeoff between increased exports vs higher debt costs. Let's pivot now to both what I suspect will happen and the current state of affairs in China. First, China does not have the USD they claim. Their statistics on how many USD they have is straight up bogus. It's tight 7/n
Second, they cannot let the RMB fall without running an exponentially increasing risk of a major crisis. Again, by USD amount against the economy, but if people won't roll over the loans because they fear a falling RMB, they won't be able to source international USD and 8/n
will ultimately burn through FX reserves. Even if it just absorbed a significant share of short term debt, assuming numbers are real, would bring them down to $2-2.4 trillion a scary adjustment in todays world. Third, they are not going to float the RMB. Just no. 9/n
Assume they open everything up, houses are sold, cash is pulled from banks, real estate and banks collapse from astronomical valuations. That is what we call shooting yourself in the face to kill the fly on your nose. Beijing will not let the RMB drop materially further or 10/n
open the RMB. They cannot do either without triggering a major crisis. Fourth, at the end of the day, this is all about Beijing refusing to make any meaningful change reform on economic matters. They believe they can endure a lot more pain and will impose a lot more domestic 11/n
pain than the US. Fifth, Beijing is starved for USD and the trade war significantly exacerbates that. US doesn't care if the business goes t Vietnam or Mexico, China needs that USD in a big way. Sixth, all of these problems at the end of the day are the result of a decade 12/n
of bad decisions by China. In something significant happens out of Trump actions, it is the straw that broke the camels back not the shot gun blast to the face. The problem is, and I kind of sympathize with Chinese policy makers here, they have used so many things to 13/n
Delay any real decisions that their range of options is considerably narrowed from even a few years ago. Their banks are sitting on a mountain of bad loans, under capitalized, Chinese asset prices are absurd relative to cash flow, with real estate and related industries 14/n
as the only growing sectors. Beijing does not have any good options, only less bad options. In your 20s have fewer cheeseburgers, in your 30s have some sushi, your 40s exercise, 50s here is a strict diet, in your 60s you get heart surgery. China ain't in its 40s and smokes 15/n
The one thing that worries me is there are many reports about noneconomic measures Beijing may take. At this point in history, that is a very concerning possibility. There are things to debate about how the Trump administration has handled this entire subject, but 16/n
This is without any doubt whatsoever not a trade war over a specific behavioral problem but a clash between competing world views about how the world should operate. How your view the fall in the RMB, depends on what you hope to achieve. Beijing can't go further. Done
