Notes From Underground: Into the Weeds on Yen/Yuan

In the first post about the YEN/YUAN, we discussed the current significance of the cross, and with it a rising dollar. Now we will provide CONTEXT and NUANCE as to the backdrop of this cross’s significance. It is easy to forget that the Chinese economic miracle is only 40 years old as it began under the direction of DENG in 1978-79 and his rise as China’s leader. By 1994 China is beginning to feel the positive effects of Deng’s policies of white cat/black cat in pursuing modernity and western-style economic growth.

In an effort to become more competitive on a trade basis China devalued the YUAN on January 1, 1994 by 50% moving its currency to 8.7/dollar from 5.8 overnight. It also happens to be the day that NAFTA took effect. China was very aware of the regional impact of NAFTA and by depreciating its currency hoped to use its skilled labor and low wages to jumpstart its global economic impact. It’s also important to note that by this time NAFTA had been a response to the growth of the Asian tigers and the huge growth in exports from Thailand, Indonesia, Malaysia, Taiwan and South Korea as global capital was set in motion to “exploit” the low wages of Asia. The day China devalued its currency the yen/yuan cross was 19.22. But by Christmas 1994, foreign capital destined for Mexico failed to appear, opting instead to move into Asia and crushing the Mexican economy as a result.

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Yet by July 1997 some of the Asian Tigers were experiencing stress as Chinese exports created an overcapacity issue, driving prices lower. This caused massive losses in the tigers and proved that their currencies were too strong, which made China far more competitive. So the uber-cheap Chinese wages and beggar thy neighbor currency advantage undermined the nascent Asian middle classes. With the Chinese miracle in full bloom, President Bill Clinton embarked on a nine-day trip to Beijing with a 50 member party that included business executives. (It’s important to note that Clinton didn’t stop in Tokyo, which ruffled the Japanese.)

Prior to President Clinton’s trip, the U.S Treasury on June 17 intervened to BUY Japanese YEN, which had fallen over the previous year. The White House said it was done at the behest of the Japanese but that was/is highly doubtful. The New York Times noted at the time that “The action was evidently motivated, as well, by public statements from China, where Clinton begins a nine-day visit next week, that it might be forced to devalue its own currency if the YEN continued to fall.”

In the run up to the intervention, the YEN had DROPPED 18% versus the dollar and 23% versus the YUAN as the YEN/YUAN went to 17.49/yen from 13.82. The U.S. intervention to strengthen the YEN caught markets by surprise as just three weeks before that, U.S. Secretary of Treasury Robert Rubin delivered a key speech on the desirability of a strong dollar. But the belief that it was the Chinese complaining to the White House about YEN weakness. As the capitalist world continued its path to China in search of its markets and cheap labor the Chinese economy expanded dramatically, acting as a key ingredient to stabilizing the global economy during the global financial crisis in 2008.

As the U.S. began to recover — aided by massive amounts of central bank liquidity — the Chinese economy continued growing by enormous amounts. The Japanese, still mired in economic lethargy, remained committed to its path of zero interest rates. In an effort to have its global corporations be able to compete with other multinationals Japan invested massive amounts of capital into China to take advantage of high quality, low-wage labor. By June of 2015 the Japanese YEN was at its weakest in 10 years, trading at 125/dollar and 20.22 /YUAN, the lowest level in the time of the Chinese miracle.

In August 2015 China devalued the YUAN by 3%, but this came at a time when the YUAN was strong against the DOLLAR at 6.23, even as the FED was preparing to raise interest rates and lay out the steps that would eventually become its balance sheet unwind. That was sending the YEN lower against the dollar and the YUAN — and again the YEN/YUAN cross was at 20.25. The Chinese action scared global markets and the FED actually slowed its tightening rhetoric — though it eventually raised rates in December. For the next year, the YEN actually appreciated by 25% versus the dollar to 103 and the YEN/YUAN rose by almost 25% to 15.50 from 20.25 a year earlier.

Fast forward to present day where the YEN/YUAN is 19.60 and DOLLAR/YEN is at 128.55. Can the FED continue on the path of aggressive rate hikes and balance sheet reduction? Will the Chinese allow the YUAN to strengthen and blow out the 2015 high of 20.25 YEN/YUAN? (Note: It matched that level three weeks ago.) Will a strengthening dollar result in a MASSIVE DELEVERAGING as borrowers seek to raise dollars in an effort to avoid default as U.S. rates rise, excess liquidity ebbs and pressure to avoid default rises?

THE MOST IMPORTANT QUESTION REMAINS: EXACTLY HOW MUCH LEVERAGE REMAINS IN THE SYSTEM due to the liquidity programs of the world’s major banks? Most of all, can XI tolerate a global and domestic slowdown simultaneously? All I know is if the Japanese had asked for help last week and Yellen said NO it was a great blunder as the Japanese under Kuroda are pledged to the foolish Yield Curve Control, which caused such havoc in Australia. How do you prevent YEN weakness and all its impacts without global intervention? Nothing is ever as it seems.

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