The Fed’s Bark is Loud; the PBOC’s Bite will be much Worse

Andrew Browne’s article, from yesterday’s US print edition of the Wall Street Journal, (see Yuan’s Fall is Just Noise) nicely captures the current situation and market sentiment as it pertains to the confidence in the renminbi. Only the day before China warned off George Soros from attacking its currency. This sounds like red rag to a bull, if you ask me. But the real point is valid: if the market perceives an imbalance or a weakness in a currency it will take a position. In this I am betting that Soros would hedge for a fall in the Chinese currency. And the PBOC would be required to use interest rates and its diminishing currency reserves to defend and control the fall. It has already used close to $800m of what was a $4tn war chest.

Since the PBOC is not keen to use its powder – and since it had little experience in how to survive such a new phenomena as a free market driving its currency value – it will likely turn to capital controls to help stem the flow of currency leaving its shores.  As the Fed raises rates, more and more money is changing direction from emerging markets, including China, back to the US.  So even though the press and pundits in the west are looking at the bark that is the Fed with its meetings and minutes, and discussions about the odd quarter point rise in rates, the reality is that what China does, it’s bite, will be far more impactful on the global economy.  

I noted the other day that China will likely look to introduce capital controls since history books will have shown its economic guru’s that this helps control the flood. Well when you read your newspapers this morning you will note that it the process has begun, rather quietly too.  In the Financial Times you can see Capital Controls no longer taboo in fight against flight, and in the Wall Street Journal, Beijing Moves to Slow Money Outflow.  The next phase of the economic cycle is about to get started and it won’t be pretty.

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