Currencies

China’s problems ‘just gargantuan’

Jessica Hartogs, special to CNBC
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Despite China's yuan hitting its highest level this year against the U.S. dollar Monday, the country's fundamental problems are "just gargantuan", Stewart Paterson, portfolio manager at Tiburon Partners, told CNBC.

"They (the Chinese) have deflation, they have a slowing economy," said Paterson, "To say there is no downward pressure on the RMB (Renminbi) or no fundamental reason for it to weaken, I think is very disingenuous and symptomatic of the fact that the Chinese population themselves are starting to lose confidence in their own currency."

The Chinese authorities are bolstering the yuan, in part, by selling off chunks of their foreign currency reserves and dumping dollars in the market. Nonetheless, the money stock in China is growing about twice the pace of its economy, at about 14 percent year-on-year.


Chinese bank staff member counting stacks of 100-yuan notes at a bank in Huaibei, China.
AFP | Getty Images

"If using your foreign exchange reserve is just a way of tightening monetary policy, as you support your own exchange rate… [then] the POBC (People's Bank of China) are easing monetary policy by handing money out to the monetary market," said Paterson.

"This is the equivalent of drinking whiskey and taking aspirin at the same time… what you're doing with one hand is counteracting the effects of what you're doing with the other."

Paterson believes the yuan could devalue by a further 35 percent.

A customer holds a 100 Yuan note at a market in Beijing.
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However,economist George Magnus does not believe China will devalue the yuan in ways "that people think it will be forced or choose to."

"Instead, and if pushed by the capital flight that's bleeding its reserves, China's basic instinct will be to carry on tightening capital controls, and punishing those that try to breach them," he wrote in a note on Friday.

And what is happening in China is having repercussions across the world, not least Europe, said Paterson.

"If a country could just print as much money as it wanted, and at the same time, preserve the external purchasing power of its currency, clearly there would be no poverty in the world…we would have all done this," he said.

"The failure of Europe to generate nominal GDP (gross domestic product) growth is why the leverage is so damaging. The credit risk is rising in the risk-free sovereigns, which the banks are all up to their eyeballs in … and so a deflationary shock from China that makes nominal GDP growth in Europe an ever more distance prospect , of course that manifests itself in real stress in the European financial system," he said.

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