Thread by @michaelxpettis

1/10
Regulators seem to be increasing inspection of the activities of onshore FX traders, according to this article, forcing them to cut back on derivative products, to tighten bid-offer spreads and to reduce trading volume.

reuters.com/world/china/ex…

2/10
As I have long argued, all the over-excited talk about the RMB becoming a major global currency is regularly undermined by regulatory actions aimed at protecting the Chinese economy from the costs and risks associated with major global currencies, and this is...

3/10
perhaps just one more example. Beijing seems especially worried about the vulnerabilities created by the recent opening-up of its financial markets to foreign investors, and is worried that changes in US monetary policies could be disruptive domestically.

4/10
Beijing is right to worry. China's fragile and inflexible financial markets, underpinned mainly by moral hazard, are susceptible to the classic developing-country risk in which the effect of a period of high inflows on the financial markets make them unable to absorb a...

5/10
subsequent period of high outflows. As long as Beijing has these conflicting objectives — make the RMB a major global currency and prevent the costs and risks associated with having a major global currency — its currency policies are likely to be confused and contradictory.

6/10
I am particularly intrigued by this idea of forcing traders to offer tighter bid-offer spreads and requiring them to reduce trading volume. The risk a market-maker takes is a function of his...

7/10
holding period, which is inversely related to his turnover. A market-maker's profit is a direct function of the bid-offer spread and his turnover. Normally more trading volume leads to tighter spreads and tighter spreads encourage more trading volume.

8/10
By requiring that market-makers reduce their spreads as well as their turnover, I wonder if the result won't be a lot more unnecessary volatility as traders respond by refusing to make continuous markets, especially in down markets.

9/10
I suspect they will also try to make up for the reduced profits by positioning more, which also tends to exacerbate volatility. I remember during my trading days when the huge entrance of new players in 1990-92 caused bid-offer spreads in Latin American debt to collapse.

10/10
One consequence was that most of the smaller players could only make money by speculating heavily, and in the 1994-95 crisis, even though many of them abandoned their clients when things got choppy, they still lost so much money that they dropped out of trading altogether.