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  • Writer's pictureOwen

Will the RMB collapse in 2016 Q&A

How far will the RMB fall in 2016?

The trend for the RMB compared to the US dollar seems clearly down right now.  What does this mean though?  Is the government letting market forces find the value?  Is it a sign of coming collapse?  Is it government policy?  If so, where will it end up?  To predict where the RMB might go this year we must understand the major factors driving the currency.

It’s not me, it’s USD.

To those who think the RMB is slumping it is worth keeping in mind the US dollar has been on a rocket ship the last 12 months leaving many currencies cast off burning in their wake.  We aren’t just mentioning the Australian/Canadian Dollars or the Brazilian Real, it is also the Euro, the Pound and the Yen.  A small decline of 4.5% in 2015 against the US dollar for the RMB still puts it in uncomfortably strong territory.

If we assume that the US progressively raises rates, or even just stays pat this year (as seems likely to us), whilst the rest of the developed world, and even China is stimulating and lowering rates hoping for stronger growth, the mighty dollars days look set to continue.

The best thing in life is free stimulus.

It is no secret that the Chinese government has been gently trying to support the economy without reverting to old bad habits like force feeding loans onto state controlled banks in a desperate construction binge.  Letting the currency slide to support exporters and attract investment for the embattled manufacturing industry which has faced double digit wage growth for the last 10 years fits the bill.  Further with commodity and energy prices sliding like the 49ers/Chelsea football team there is very little inflation pressure that would normally prevent a currency devaluation.  Given current conditions, this also looks set to continue in 2016.

Sticky fingers; sticky currency.

Despite all the downward momentum, we think the defining factor for the Renminbi in 2016 will continue to be the government.  It is clear the Chinese government is happy for the currency to slide, but how far and fast?  Given the current leadership’s close personal experience with extreme instability during the cultural revolution, instability and chaos is to be avoided at all cost.   How will the government keep control? In most countries you would have seen the currency react in a far bigger way given the current fundamentals, but then, China isn’t most countries.

You are with us or against us.

There are a plethora of rules that restrict currency movement in China but given the number of holes in the capital walls the “other” ways of getting companies both public and private to support government policy are even more important.  Witness the investigation of short selling a few months ago and the recent suspension of 3 banks foreign exchange licenses due to “unnecessary arbitrage”.  I’m no lawyer, but my understanding is these activities were clearly legal, but the message is loud and clear that when doing business in China actions that work contrary to government goals won’t be tolerated.

The $3.4 trillion dollar wall.

Still, there are many legal ways to get money out and the flow from millions of average investors and private companies has meant that the government was forced to support the currency in 2015 to the tune of $600 billion USD.  For most governments that would be impossible or at best presage a crisis.  China however started the year with $4 trillion US dollars in foreign currency reserves and nowhas around $3.4 trillion USD.  This is quite the rapid decline but the amount is the world’s largest and remains plenty.  It is sufficient for the government to achieve its goals for the next couple of years even assuming continued currency support.

Sun Tzu: Let your plans be dark and impenetrable as night, and when you move, fall like a thunderbolt.

In financial markets, a steady trend, like currency decline, can build expectations and makes the possible, probable and then certain.  A continued slip can lead to an unseemly collapse.  The government mandarins know this and a panicked collapse is the thing they want to avoid most of all.  So even though a decline is their goal, panic is not, so they will push back from time to time to make the trend reverse and keep the market unbalanced.  Sometimes this push back might be for a day or two and might be severe.  Sometimes it might be a for week or possibly even a month or more, so be careful with short term trades no matter the strength of the overall trend.  This recent push back is case in point.

So, where are we going this year?

Some of this depends on the strength of the US dollar but we believe the recent history of the rise of the Renminbi is instructive in understanding government operations, which is the primary factor.  The rise was constrained to 6-10% per year in a pretty orderly fashion, with the occasional little dip to keep people unsure.

We can see since the beginning of 2014 however that volatility has risen and the decline of the Yuan in the brief start of 2016 has been far faster, moving 1.5% in 7 days.  We don’t however expect a 78% annualized rate to be continued, far from it.  Still, it is likely to be faster than 6-10% given the increase in volatility the last 2 years and the fact it matches government goals.  Still it won’t be much more since progressive steady-as-she-goes movements remain the government’s modus operandi.  This thus gives us a range of 10-15% decline in 2016, or an exchange rate with US dollar of 7.12 to 7.45 by year end.  Still it’s a forecast so it is unlikely we will be as accurate as our last Renminbi forecast.

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