Like the old Soviet Regime, certain market regimes seem to be entrenched so thoroughly, that it is impossible to visualize any mechanism, by which they can be dislodged. But the Soviet Union fell and did so in a fashion few could have foreseen.
Until only a few years ago, Japan appeared to be caught in the never-ending purgatory of deflation, sagging growth and capital markets, and meaningless reform promises. In 2012, the current account surplus was not scheduled to elapse for a few more years, and the market flows, according to strategists, continued to support the yen. And then the sudden collapse of DPJ and Abenomics. You know the story.
And you also know the story of the Swiss Franc. First it was immovably pegged at a too weak 1.20 exchange rate to the euro. Then the immovable and indestructible peg suddenly evanesced. The franc briefly rallied above parity, which was way too strong. It appeared that the SNB had no means to control the currency appreciation. Until they did. And guess what? EURCHF drifted to somewhere in between 1.00 and 1.20. Probably where it should have been to begin with.
You probably can see where I am going with that. If general economic principles and historical patterns dictate that something has to happen, it probably will. Even if you see no possible mechanism to drive the transition.
Which, of course, brings us to China. In my post
from June 13, 2015,
I reviewed a book by John Mauldin and Worth Wray A Great Leap Forward?
I conceded that both China bulls and bears were making strong points. And with regards to currency I was giving heed to both those who said that a massive devaluation was inevitable and those who pointed out the imminent deval was neither necessary nor in the interest of the government.
There were few precedents to establish how price and credit overextensions unwind in tightly controlled communist/capitalist markets.
Personally though, I leaned to the bearish case for both equities and currency, based on the historical pattern for countries with credit growth excesses. Until proven wrong, I had to assume that the “what” of the equities correction and currency deval, even if I didn’t know the “how”.
And given that I ALWAYS put my money where my mouth is, my strategy did not permit me not to trade accordingly.
It was not cheap and my timing was not perfect. And today it is too early to celebrate victory: all my gains are reversible.
Now what? Do I stick to my guns and expect more of the same?
If you were wondering why I haven’t posted any anything extensive on the RMB devaluation thus far (I suspect you have better things to do than to wonder why I don’t post): I had relatively little to contribute to the discussion. I don’t have a clear idea why they did what they did and what their long-term plan is.
So in the absence of such insights, I have to stick the fundamental principle which drove the China trade, as well as other examples above:
Unsustainable will not be sustained.
If you see a major dislocation what have to bet on it eventually being rectified, even if you fail to understand the mechanism of the shift.
One of the reasons I prefer simple directional trades is because the “what” of the market is often easier to discern than the “how”.
And with the respect to China, if (and that’s a big if) you believe that the major dislocations are still there, it is reasonable to assume that they won’t be fixed by a 5% currency move. And so, regardless of what the authorities may have in mind, the odds are skewed towards further devaluation.
Chart source: Yahoo! Finance
Image: The Unstoppable Wave by Theophilos Papadopoulos
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