What was it that touched off CNY’s devaluation in the first place? When it started, “unexpectedly” of course, it was described as intentional policy designed to thwart speculators betting too heavily on the currency’s continued rise. But the first major move in the chess game between the PBOC and “whatever” it is driving the currency was to widen the daily band, an important clue that had very little to do with speculators and everything to do with China’s banks. It was then and remains today those very same banks often in desperate need of “dollars.”

In March 2014, the PBOC even went so far as to authoritatively declare, “there is no basis for big appreciation of the renminbi.” Only there was, it just wasn’t what anyone thought it was. I wrote instead, with admitted frustration:

In the Journal’s formulation, the PBOC is directing affairs, sending out “instructions” that Chinese banks should “aggressively purchase dollars” ostensibly to punish those hot money speculators. Given what we know of copper and dollar financing in general, is that really the case? Is it not more likely that the PBOC has lost control of dollar conditions and was forced by the “market” to widen the daily band in order for dollar-starved banks to aggressively bid for dollars they could not otherwise obtain?

 

What all this data shows, as opposed to conjecture about the supernatural powers of central banks, is that yuan’s devaluation may be directly tied to dollar shortages. In fact, as I argue here, it is far more plausible that a dollar shortage (showing up as a rising dollar, or depreciating yuan) is forcing the PBOC to allow a wider band in order that Chinese banks can more “aggressively” obtain dollars they desperately need. Worse than that, the PBOC itself cannot meet that need with its own “reserve” actions without further upsetting the entire fragile system.

Neither my frustration nor the madness that triggered it has changed despite three years of very direct and unambiguous evidence demonstrating conclusively what I said was absolutely correct (right down to the mention of the “rising dollar”). What was left for speculation was only what may have started it all in late 2013. I believe it all traced to the idea of reform and how all of a sudden that meant for the first time for China the widescale prospect of default and credit risk.

In so many ways we are just repeating these processes over and over again; is this 2017, or 2014? Each time it appears to have ended, and everyone breathes their collective sigh of relief, the world goes back to its ignorance having learned nothing. The confusion over the darkest moments cracks open the door to mainstream curiosity just enough to become hopeful that they will start to get it, only to have the mere fact of avoiding another full-scale 2008 slam it shut as if that is the only relevant concern and biggest risk. The worst case is not, in fact, a repeat of the panic, for that might actually be now our best case, the only way to dispel once and for all the myths of the past so as to become free from this interminable depression.

It has been assured all over again that China is fixed and that the PBOC is still omniscient – even though more curiosities have, just in the past week, suddenly arisen.

The banks’ withdrawals helped erase $315 billion of stock market value over the past six days and sent bond yields to the highest level in nearly two years, highlighting the challenge for Chinese authorities as they try to rein in shadow banking activity without destabilizing financial markets. While the government has plenty of firepower to prop up asset prices if it wants to, forecasters at Australia & New Zealand Banking Group Ltd. predict the selloff will deepen this year. [emphasis added]

Not only are there liquidity problems tied to more shadow bank activity beyond what was known of Wealth Management Products, it was also reported that Chinese debt is far more Japanese (pre-2000’s) than was feared. There are, apparently, a great many off-balance sheet guarantees often between the same two firms (both guaranteeing each other’s debts) in what begins to look like Japan’s keiretsu. Despite the debt problem, like early 2014 we are emphatically assured there is nothing to it, at least nothing that the mighty PBOC can’t get right. Sure.

One thing is certain, liquidity in China is tightening. It is also doing so dramatically and in strange ways. Overnight SHIBOR surpassed 2.70% last Friday, and was nearly 2.76% today, a far cry from the 2.05% “line in the sand” the PBOC clearly enforced for nearly a year. We are supposed to believe that if SHIBOR moved far from that range it must have been because the PBOC wanted it that way. But even if that was true, the way in which rates have risen cannot be anywhere close to the desired method.

(Click on image to enlarge)

(Click on image to enlarge)

Interest rate swaps on O/N SHIBOR have curiously diverged at the 1-month from the 3-month maturities. Not only is that extremely unusual, the 1-month IRS price is for the past few days substantially less than the spot SHIBOR rate. Meanwhile, the 3-month IRS appears to be at least recognizing what is a durable trajectory even if the spot rate is highly volatile in getting there. It sure seems like “someone” is acting on the 1-month IRS for purposes unknown.

Given the arrangement here, there are really only two possibilities. The first is that private market participants are increasingly convinced that conditions will in the short run (why it’s lower at the 1-month but not 3-month) become so bad that the PBOC will have no choice but to act and act forcefully (RMB accommodation). The other option is that the central bank is artificially holding down the 1-month IRS (likely in conjunction with other arrangements) the net result of which it hopes will make it seem like markets aren’t as concerned over liquidity as they appear everywhere else. Neither option suggests the PBOC is in solid control.

(Click on image to enlarge)

(Click on image to enlarge)

(Click on image to enlarge)

We have not in our experience before confronted anything like this. By all mainstream accounts and philosophy, crises or negative events are discrete, temporary things that the world must from time to time endure but having done so always move on from it. It seems like the impossible for there to be the same problem underneath year after year (after year, and then seven more times). Some of that is due to really bad theory related to the domination of statistics in both economics as well as finance, the random walk where we are led to believe what happens today is not influenced by what happened yesterday, or last year (or in August 2007).

There are so many misconceptions about how the global system actually works that it is no wonder the populist backlash; almost everything authorities and authoritative opinion in the media tells us is wrong. It does seem like they are at times just lying to us, because they can’t possibly be so constantly ignorant, frivolous, and unprepared. Johann Wolfgang von Goethe wrote in the 18th century that, “misunderstandings and neglect create more confusion in this world than trickery or malice.” Count Axel Oxenstierna, Lord High Chancellor of Sweden in the 17th century warned his eldest child, “Do you not know, my son, with how little wisdom the world is governed.”

We are so very modern, but humans are, after all, eternally human. That means, as Upton Sinclair also observed, “It is difficult to get a man to understand something when his salary depends on his not understanding it.”