We have not talked in depth about China in a while. In many ways, the Chinese government would prefer to keep its currency out of the spotlight.

You may remember that one year ago, the volatility of the Chinese yuan was one of the root causes of a 10 percent drop in equities worldwide. The core concern then, as now, is how China could service its high debt level – and in particular its high level of U.S. dollar-denominated debt.

A year ago, capital outflows were depleting China’s foreign currency reserves so quickly that the country could no longer use those reserves to support its currency. China’s foreign exchange reserves came down from a 2014 high of about $4 trillion to near $3.2 trillion in early 2016, with many pegging $2.7 trillion as the point where its reserves would be dangerously low.

At that time several high-profile hedge funds – including some that famously bet against the U.S. housing market ahead of the 2008 financial crisis – were very public about their short position on the currency, betting that it might collapse.

However, as the year went along China’s reserves eventually stabilized around $3.2 trillion. The yuan did lose nearly 6 percent of its value, but most of that weakness occurred in the fall, when the world was focused on the U.S .election and the market aftermath.

In 2017, the situation isn’t much different from a year ago but there are some interesting twists. China’s reserves have dropped fairly quickly to nearly $3 trillion in the past couple of months. If the same pace of reserve depletion continues, China could find itself getting near that $2.7 trillion level by summer. 

The big difference this year of course is that we will have a new incoming administration, with different views on trade and currency manipulation. 

My View: China’s economy faces the same problems, and has many of the same advantages, that it did last year. But today’s geopolitical environment is far more complicated. We should get some clarity on the future of the yuan during the first few weeks of the new administration and as an understanding emerges about what course the U.S. Federal Reserve is likely to take this year.

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