Monday, August 17, 2015

Note to Self: China M-Policy Choices

Which one is better?

Maintaining a dollar peg, while easing policy rates to counter peg-induced tightening? And promising Yuan will perhaps appreciate from here? In short, ask the savers to suffer, the conscientious borrowers to pay down the debts, the risk takers to continue their carry trades and corporate sectors to go fend for themselves.

Or let the currency adjust, and support with policy easing. Market mayhem and overshoot for a while. In the end it dies down. Effectively take money from importers/ foreign currency borrower and would-be tourists and give it all to exporters and foreign currency lenders. Kill the carry trade (and traders). The downside is huge vol now, and a very hard time convincing the markets if you need the peg ever in future (fool me once etc.). The outcome hinges on credibility and strength of FX reserves entirely.

Lastly, let the devaluation drag on a little at a time. Highly credible. Less volatility, and that too most of it elsewhere (EM). Pernicious if "no further devaluation" not credible, as expectation of further devaluation put pressure on capital outflow. The entire thing gets leverage out of the Impossible Trinity, potentially ending similar to above, but with PBOC looking like a fool.

Most agree CNY is overvalued. If PBOC does a full devaluation at one go closer to the fair value and promise no further action, most will be willing to believe. The question is can they? With Fed yet to decide, and other central bankers yet to see the market response, it is hard to see what is full devaluation.

There is a chance of a further devaluation in CNY once the Fed is done with their move. This present one was perhaps an unwanted and ineffective decision. Or PBOC's way of testing market reaction/ warning market participants. Or PBOC trying to fore-warn the Fed. Or whatever.

Take your pick.

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