On August 11th 2015, the People’s Bank of China announced that the country would be devaluing the Chinese yuan (CNY, also known as renminbi/RMB), knocking off more than 3% of its value against the US dollar in a matter of days. Starting about a month later, Bitcoin trades settled in CNY began increasing in number, from pre-devaluation levels of around 70% in July to over 90% of all Bitcoin trades by December. Bitcoin trading in CNY stayed above 90% of all Bitcoin volume until January of 2017 when Chinese investors seemingly abandoned the cryptocurrency following a ban on all trading in digital currencies for Chinese financial institutions. By September of the same year, The People’s Bank of China (which is also the central regulatory authority of financial institutions in China) announced that exchanging digital money would become illegal for private citizens of the country as well. Around the same period, increases in the percentage of imports from Hong Kong to mainland China in precious stones caught the attention of analysts.
This article takes aim at investigating what trading volumes in near-alternative assets classes to the Chinese yuan (such as Bitcoin, precious stones and gold) can tell us about the health of the Chinese currency, and in turn, China’s economy. The essay was written on the 28th of September 2019. Estimated reading time is 10 minutes.
The official story out of China has since the 1980s been that the government maintains control over the country’s currency by enacting laws limiting individuals to move more than $50,000 out of the country per year and companies to exchange CNY for foreign currencies only for approved purposes. This, all in the name of “avoiding big daily fluctuations“. The unofficial story among investors in the know however, has of course been quite a different one. For over a decade now, Chinese investors and companies have been funnelling money out of China to various non-CNY based assets such as luxury housing in London, New York, San Francisco and Paris (causing massive housing bubbles), gold, gemstones and offshore bank accounts to the tune of hundreds of millions, even billions of US dollars.
Effects of Capital Outflow from China
It should go without saying that an increased capital outflow from China directly weakens the Chinese yuan (CNY). What it effectively means is that people holding the Chinese currency (mostly Chinese investors) prefer to store (at least part of) their wealth in assets and/or other currencies, as a hedge towards potential future CNY devaluations or depreciations. Buying a town house on the Upper East Side when the Chinese yuan is strong relative the USD enables a Chinese investor to store part of his wealth in the US, which he might consider safer than holding that capital in CNY. In the purchase, the CNY the investor uses to buy the building is moved to what ever bank was used to settle the purchase. Banks only want to hold on to certain amounts of each currency relative to other currencies, and so will also be looking to get rid of CNY as the number of such transactions increases, causing the value of the CNY to fall relative to what ever currencies Chinese investors are buying in.
Bitcoin Trading Volume and USD/CNY Rates
“As the People’s Bank of China tightened capital controls and the yuan continued to weaken, Bitcoin became an increasingly attractive way for Chinese residents to get their money out of the country”
Relationship Between Chinese Currency Devaluation and Bitcoin Trading Volume in CNY
The chart below shows Bitcoin trading volume settled (bought/sold) in Chinese yuan (CNY) starting in May of 2014, until March of 2016. As we can see, the amount of Bitcoin bought and sold for Chinese yuan had been at a steady rate of between 1–2 million per week from going as far back as May of 2014 until August of 2015, when the trading volume settled in CNY doubled from its earlier peak of 5, to 10 million. In the coming months, the volume would nearly double again, to 20 million a few months later and peak at 35 million in February of 2016. At this point, Bitcoin was trading at about $250, or CNY 1,590. For comparison, see Chart 2 for the (for BTC, modest) price increase of BTC versus USD in the period six months before and after the CNY devaluation.
As we can see in Chart 1, trading volume in CNY began rising more or less immediately after the People’s Bank of China announced the devaluation of the yuan in August of 2015. Why? Well, one can of course never know these things for certain, but investors were surely worried that given falling exports, the devaluation— which was the biggest one-day devaluation in over 20 years — might represent an effort by the Chinese government to boost the economic slowdown the country has been experiencing since 2010 (BBC, 2019).
More consequentially, the devaluation may have signaled to investors holding assets in CNY that the criteria by which the People’s Bank of China calculates its daily “reference rate” had expanded. The somewhat unique practice of having a government assign a value to its currency relative to other currencies (the USD) was even before the devaluation already viewed by investors as dodgy at best. With a one-day devaluation of 1.86% relative to the USD, investors holding CNY may have gotten worried that this would not be the only devaluation of their CNY assets they could see — and so began looking around for alternatives. No doubt, cryptocurrency was surely an interesting (read: pseudonymous), new asset class at the time.
Chart 3 below adds additional fuel to this fire. Look at the price of Bitcoin alongside the price of CNY in USD in the same period, and the following six months.
Bitcoin Trading Volume, Other Asset Classes and USD/CNY Rates
As we saw above, exchanging digital money in CNY was made illegal for all Chinese financial institutions and citizens in September of 2017. For this reason, Bitcoin trading volume settled in CNY (which had peaked between October and December of 2016, at around 99% of all transactions), collapsed to 37.3% in February of 2017, to 21.1% in March, and 0% by November.
Relationship Between Chinese Currency Devaluation and Precious Stone Imports
As Bitcoin trading volume settled in CNY increased from 2015–16, another curious chart also emerged. From January of 2015 to May of 2016, according to a report from RBC Capital Markets, precious stone imports from Hong Kong to mainland China increased, drastically, from under 10% of the total value of Chinese imports from Hong Kong in January of 2015, to over 75% in May of 2016. As Chart 5 illustrates, this increase was steady and dramatic:
If you’ll excuse the chaos of the following chart, we see the above chart of precious stone imports also tracks very well with both the gradual devaluation of the CNY against the USD and the price of Bitcoin at the time:
So what does this tell us? Well, first off, nothing for certain. What we’ve found is a correlation between three asset classes which seem to have moved together over the period of approximately 18 months, while numerous other macroeconomic events occurred simultaneously. We have in other words not found any evidence of causation, only, perhaps, correlations. However, at least from the point of view of our investigation into the health of the Chinese yuan, this correlation is intriguing.
Enter Donald Trump
Donald Trump was elected President of the United States two months after Chart 3,4 and 5 end, in November of 2016. The following chart shows the development of the USD versus the CNY in the period we’ve evaluated above, and Trump’s first fourteen months in office:
As we can see, Trump’s election (combined with other factors) likely hit the USD hard against the CNY, from a rate of close to CNY 7,0 in October 2016, to a low of under CNY 6,3 in March of 2018. In this period, perhaps not so curiously, precious stone imports as a percentage of total Chinese imports from Hong Kong reacted to the decrease, and so decreased as well:
As Trump got elected, trust in the USD may in other words have weakened among investors and so both the USD and alternative/less liquid assets (such as precious stones) became less attractive to investors holding CNY. The volume of Bitcoin settlements in CNY from the same period shows a similar (albeit much more drastic) trend, likely fueled by the People’s Bank of China’s ban on domestic financial institutions’ dealing in cryptocurrency, announced on December 5th 2016:
Down to the point
We’ve observed what seems to be non-trivial correlation between decreased trust in the CNY and increases in trade in alternative asset classes from Chinese investors (or, at the very least, investors buying and/or selling to/from CNY and/or importing precious stones to mainland China).
Let’s next expand the charts of the three asset classes we’ve been tracking (USD/CNY, Bitcoin and precious stone) to add the period from the low of the USD (and precious stone imports, and Bitcoin settlements in CNY) in March of 2018, up until January of 2019.
Relationship between Trust in Chinese Yuan and Precious Stone Imports
“In November , precious stones — diamonds, sapphires, opals and the like — accounted for 53 per cent of China’s total imports from Hong Kong, up from a low of just 2.9 per cent last February” — Elsa Lignos
The Trump administration began announcing tariffs on Chinese imports in January of 2018. Throughout the year, increasingly in a tit-for-tat fashion, one country’s goods became more expensive for the other country’s companies and consumers. Starting around the same time, the US dollar strongly rebounded against the CNY, from its low of under CNY 6,3 in March to a high of nearly 7,0 in November of 2018:
Elsa Lignos, Global head of FX Strategy at RBC was the first to report on the response of this more recent weakening of the CNY, in precious metal markets. RBC’s report, discussed in the Financial Times in January, again show a considerable uptick in the precious stone imports as a percentage of total Chinese imports from Hong Kong, to a high of 50% of all imports to China in January of 2019:
As Bitcoin was already banned for Chinese financial institutions and citizens at the time, we do not know the effects of the decreasing trust in the CNY on the trading volume in Bitcoin and other crypto currencies.
Where does that leave us?
People have speculated that those in the know were able to get money out of China through trade in asset classes such as Bitcoin, gold and precious stone imports, prior to the CNY devaluation of 2015. Although Bitcoin is no longer traded to and from the Chinese yuan, it and other cryptocurrencies remain a popular asset class in other countries experiencing weakening currencies.
The website Bitcoinity keeps track of and offers free Bitcoin trading volume data, including breakdowns for all the major currencies. Look into Argentina, anyone?
I am not a financial analyst, nor is any part of this or any article I publish meant as financial advice. The data featured in the above analysis stems from Investing.com, BitCoinity and RBC Capital Markets (via the Financial Times).
This essay was first published in Blue Poles, a Medium Publication featuring investment ideas, essays and analysis.