Submitted by Taps Coogan on the 28th of June 2019 to The Sounding Line.

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Louis-Vincent Gave, co-founder of Gavekal Research, recently spoke with Erik Townstead on MACRO Voices about the future of Hong Kong and the likelihood of a Chinese currency devaluation, which Mr. Gave sees as low.

Some excerpts from Louis-Vincent Gave:

“The reason you have two million people in the streets, which is more than a quarter of the Hong Kong population, is pretty simple… Hong Kong has its own judicial system, its own police, its own currency, basically a special deal within China… The Hong Kong government, Carrie Lam the Chief Executive of Hong Kong, proposed a change whereby you would have a new extradition treaty whereby people would be basically extradited to China… Obviously, this was sold to the Hong Kong population as ‘all we’ll do is send away murders, and rapists, and the wretches of society,’ but nobody trusts that, before you know it, you wouldn’t have some political dissidents that wouldn’t get caught up in the net, or even frankly businessmen…”

“I think when the treaty was made (granting Hong Kong special status), the general belief was that by 2047 (when it expires), China will have evolved and probably taken on a lot of the accoutrements of a modern democracy… From 1984 to 1997, it seemed like the trajectory was a fairly optimistic one. China was getting freer economically, and the general assumption was that, following economic freedoms, you’d get civic and political freedoms at the back-end… Until five or six years ago you could still very much believe that. I think the era of Xi Jingpin has changed a lot of people’s perspectives… Rather than a move towards more civic and political freedoms, it does seem like China is going the other way…”

“If you think (current US-Chinese tensions) are a trade war than, indeed, a devaluation from China might make sense… I think it is a cold war…, or at the very least, I think that’s how China now sees it… If your a Chinese policy maker, you can hope for the best and you can hope that you do cut a deal with President Trump and that everything works out to be fine. But, I think you have to plan for the worst and planning for the worst means basically tackling your three major weakness points… The first is technology… China actually imports more semi-conductors than it imports oil. Last year it imported about $270 billion worth of foreign semi-conductors, a lot of which came from the US or at least on US patents. The second big weakness for China is oil. Last year China imported $170 billion worth of oil. And, the third and possibly most important weakness is China’s reliance on the US dollar. Most of China’s trade is dependent on the US dollar… We’ve seen in recent years the US have no qualms about weaponizing the US dollar. They’ve done it with Iran. They’ve done it with Venezuela and each time they weaponize the dollar they bring the economy that they want to cut off from the US dollar system to its knees… If you are China today, yes you can devalue and give yourself a little shot in the arm, but if you do, you’ve cut the credibility of your own currency and, down the road, you end up more dependent on the US dollar than you’ve ever been… To cut your dependence on the US dollar, there’s only one way to do it and that’s by having a strong currency.”

Mr. Gave is most likely correct that the Chinese authorities don’t want to devalue the Chinese Yuan. We can see that in their statements and actions to defend the Yuan. The question, however, is whether it will happen despite Chinese authorities’ attempts to prop it up. Defending a peg costs foreign currency and while China has large foreign reserves, it has an extremely leveraged financial system and trillions of dollars of foreign denominated debt. China’s reserves won’t last forever and with the country now running a current account deficit, their reserves have begun to shrink. They can keep holding the peg for a while, but if they are going to eventually run out of reserves, it’s better to devalue before you’ve spent all of your reserves than after.

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