The Financial Times has two stories today referring to possible consequences of China’s falling renminbi. Unfortunately they appear to point in completely opposite directions.
The titles give away the game:
Falling renminbi heightens derivatives risks
Beijing guides renminbi lower in effort to manage financial risks
Does the falling renminbi mean greater or smaller financial risks? Can it be both?
Numerous individuals and companies have bet in every way conceivable that the renminbi will appreciate. These investors are now feeling a squeeze as the People’s Bank of China has guided the currency’s value lower. For these investors, the risks are increasing as their complex bets may be coming up short and losing serious amounts of money. The first piece describes the ways that billions have been bet, mostly by Chinese companies, on the continued appreciation of the renminbi.
Given the clear danger depicted in the first article, how can the claims in the second piece be substantiated?
It takes a little detective work to unravel how guiding the renminbi lower helps China manage financial risks because it involves a vast twilight zone of financial dealings for which there is little data, official or otherwise. Nevertheless, it is the dealings in this zone – which includes domestic shadow finance and irregular cross-border capital flows – that are increasingly setting the tone for Beijing’s policies.
The PBoC has been unable to rein in the domestic shadow finance or limit cross-border flows. By guiding the renminbi lower, the losses mount for firms that have skirted the PBoC’s regulations in these dimensions. The hope is that these losses today will prevent even greater losses in the future.
Key to reconciling the views, then, is the discount rate. Do you care about the long-term? How much? Is the possibility of creating a crisis today worth it to lower the chances of an even larger crisis down the road? It certainly seems like a dangerous game, especially since so much of it is played in the shadows.
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