Here's Why China Won't Devalue And Start A Currency War

Nothing could be further from the truth. There are two major reasons why Beijing will not devalue the yuan in the immediate future:

• The PBoC isn't prepared for a major devaluation; and more importantly
• China would lose face.

My previous post (link above) used a military analogy to watch for signs of a RMB devaluation and I will try to continue that framework in this case. If you were going to war, what you would do is mobilize your troops. Rush combat aircraft to the front. Cancel all leave and call up the reserves.

We are not seeing any signs of that in China. Instead, the PBoC is following a slow and methodical script of internationalizing the yuan. One of the steps of full convertibility, which isn`t scheduled to occur until the end of 2015 (via WSJ reported that President Xi Jinping outlined the goals of the AIIB on the weekend [emphasis added]:

In a speech to a regional forum Saturday, Mr. Xi presented China as a partner willing to “jointly build a regional order that is more favorable to Asia and the world.” He highlighted a new China-led infrastructure bank and other initiatives designed to leverage hundreds of billions of dollars to finance railways, ports and other development projects, and foster regional economic integration.

Throughout the 30-minute speech, Mr. Xi stressed that China’s vision, while centered on Asia, was open to participation by all countries. He was careful not to place China at the center of this emerging order, as some regional politicians and security experts have warned could happen.

But Mr. Xi said given China’s size, it will naturally play a larger role. “Being a big country means shouldering greater responsibilities for the region, as opposed to seeking greater monopoly over regional and world affairs,” Mr. Xi told the Boao Forum for Asia, an annual China-sponsored conference named for the southern seaside town where it is held.

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Undoubtedly, the AIIB will finance itself by issuing yuan denominated bonds, once the yuan is internationalized.

China’s planned infrastructure bank will have $100 billion in capital. Properly borrowed against, that pool could provide $1.3 trillion in financing—still short of the trillions in estimated infrastructure demand, according to Fred Hu, a founding partner of Primavera Capital Group.

If China were to effect a major devaluation now with, say, a shock-and-awe QE program, Beijing would lose face in a major way. Viewed from that context, better to suffer some short-term pain for long-term gain. That's why a major devaluation of the RMB is highly unlikely in the immediate future.

* Where would we be without ZH? It's the financial equivalent of the supermarket tabloid detailing the deathbed confession of the soldier who guarded the aliens who landed at Area 51.

Disclosure: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Written By: Cam Hui