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Why China’s Number 1 Position Is Losing Ground

Surbhi Jain

Shorting the Yuan: Are Hedge Funds Seeking Their Soros Moments?

(Continued from Prior Part)

A Chinese tale: Currency eating into reserves

China’s (FXI) (YINN) number one position as the country with the largest foreign exchange reserves is losing ground. The Chinese yuan’s depreciation has been eating into the economy’s foreign exchange reserves.

With about $3.4 trillion in reserves, China holds the largest foreign exchange reserves in the world. These reserves are now depleting. The depreciating currency is eating into them.

The yuan has been depreciating

We saw in Part One of this series that the yuan has been depreciating for a while now. Its price against the US dollar hasn’t been stable at any time during the last year. Now, regulators in China (ASHR) have had to withdraw from their US dollar (UUP) reserves in an attempt to stabilize the value of the yuan against the US dollar.

Weakening central bank balance sheet

Depleting foreign exchange reserves are not good for any economy. These reserves represent the assets held by a country’s central bank, and they are used to back the country’s liabilities. Depletion of these reserves weakens the central bank’s balance sheet as lesser assets back the existing liabilities. In most cases, these reserves are used to maintain the value of the home currency.

With the yuan steadily losing its value in the foreign exchange market, authorities in China have had to buy and accumulate the yuan to keep its value from falling further. Read How China’s Currency Support Efforts Are Hurting Foreign Reserve for more information. This has resulted in China’s foreign exchange reserves depleting significantly. They are already down to $3.2 trillion from their peak of about $4 trillion reached in early 2014.

Continued depletion may erode capital market growth in China

If reserves continue to fall in China, we may see increased capital outflow as investors choose to park their money under the regime of less vulnerable central banks. Investors in China bond funds such as the Market Vectors ChinaAMC China Bond ETF (CBON) may become wary of their holdings.

In contrast, investors may want to start shorting China using funds such as the Direxion Daily FTSE China Bear 3X ETF (YANG), the Direxion Daily CSI 300 China A Share Bear 1x Shares ETF (CHAD), the ProShares Short FTSE China 50 ETF (YXI), and the ProShares UltraShort FTSE China 50 ETF (FXP), as the economy’s growth prospects come under pressure.

China has also been dominating the capital outflows of emerging markets (EEM) (EDZ) (VWO) recently.

Continue to Next Part

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