In a new report, Societe Generale analyst Albert Edwards discussed the implications of China’s forex reserve burn in recent months and what could happen when the nation can no longer support the renminbi. Edwards believes that the recent turn of events in China indicates a collapse of the renminbi is imminent.
Since mid-2014, China has burned through nearly $800 billion of its $4 trillion forex reserves, and Edwards expects that January’s data will indicate another $120 billion has been used so far in 2016. While even this much additional burn would keep China's reserve level above $ 3 trillion, Edwards believes a decline below $28 trillion could serve as a tipping point.
“Our economists estimate that when FX reserves reach $2.8 trillion – which should only take a few more months at this rate – FX reserves will fall below the IMF’s recommended lower bound. If that occurs in the next few months, expect to see a tidal wave of speculative selling, forcing the PBoC to throw in the towel and let the market decide the level of the renminbi exchange rate,” he explained.
He added that the U.S. economy would not be isolated from such a breakdown and that the S&P 500 is already showing technical signs of the beginning of a bear market.
So far in 2016, the iShares FTSE/Xinhua China 25 Index (ETF) FXI is already down 15.51 percent.
Disclosure: The author holds no position in the stocks mentioned.
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