Alan Ruskin, Macro strategist at Deutsche Bank, suggests that from net IIP data, China’s non-reserve foreign assets at 25% of GDP are a small fraction of G10 countries, highlighting the scale of potential outflows and the difficulties of pursuing financial account liberalization currently. Key Quotes • “The financial community is increasingly asking difficult questions: “What happens if the Rmb depreciates sharply by x% versus the USD? Do high beta currencies again go down by multiples of the China move? How much does China’s TWI go down, demanding more Rmb weakness? Does that mean US equities go down by 2*x%; what about oil and other commodity prices? Does the HKD peg survive; how about the SAR peg?” These are not questions in search of hyperbole. • While it is logical that China’s immediate currency tensions are addressed by macroprudential measures aimed at domestic outflows, this should not be confused with a long-term solution. • It is not too early for the US and other major global players to consider how best they can support China in a transition to a market determined exchange rate. • In circumstances where China was to depreciate significantly against the USD, the real broad USD TWI would end up in hyper strong terrain last seen in the 1981–84 USD overshoot, that only conclusive ended with the 1985 Plaza Accord. • What does a contingency plan look like? On the quasi USD/China peg, it is the US that has the strong currency. It is far easier to weaken a strong currency than strengthen a currency with a weakening bias. • Fed USD sales, and Rmb purchases could amount to US ‘foreign asset QE’. For the global economy, Fed, ECB and BOJ ‘foreign asset QE’, is an attractive proposition compared to the current China quantitative tightening (QT) incurred through the depletion of net foreign assets. • Would this go against the statement that ‘a strong USD is in the US’s interest’? Absolutely not. An overshooting USD is highly disruptive for the US and the global economy. There are some important parallels with the USD sales vs. the JPY in 1998, sanctioned by Robert Rubin, the architect of the strong USD mantra. • The extremes of the 1981-85 and 1995-2002 US dollar upswings included coordinated Central Bank dollar sales, which ultimately helped to affirm official views on value, and the exhaustion of these two big USD cycles. It is quite likely that similar actions will be needed in this big USD cycle." For more information, read our latest forex news.