Hedge fund that called subprime crisis urges 50% yuan drop

A vendor holding Chinese Yuan notes at a market in Beijing.
A vendor holding Chinese Yuan notes at a market in Beijing.PHOTO: REUTERS

HONG KONG (BLOOMBERG) - Mr Mark Hart, the hedge fund manager whose bets against US subprime mortgages and European sovereign debt proved prescient, said China should weaken its currency by more than 50 per cent this year.

A one-off devaluation would allow policy makers to "draw a line in the sand" at a more appropriate level for the yuan, easing pressure on China's foreign-exchange reserves and removing an incentive for capital outflows, according to Mr Hart, who's been betting against the currency since at least 2011. China should devalue before its US$3.3 trillion hoard of reserves shrinks much further, he said, because the country can still convince markets it's acting from a position of strength.

"There wouldn't be anything underhanded about a sharp devaluation," said Mr Hart, who runs Corriente Advisors. "Why should China be forced to suffer deflationary effects of defending its currency when everyone else isn't?"

Mr Hart, whose prescription clashes with consensus forecasts for the yuan and recent comments from senior government officials, said China would be justified in weakening the currency after central banks in Europe and Japan fueled declines in their exchange rates to stoke economic growth in recent years. Such a move would likely come as a surprise to global investors, who were rattled by a drop of less than 3 per cent in the yuan last August.

China's current approach to managing the currency's decline has been costly. Foreign-exchange reserves dropped by a record US$513 billion last year as the central bank intervened to ease the currency's slide, while an estimated US$843 billion of capital flowed out of China in the 11 months through November as some investors sought to get in front of further yuan weakness.

Aside from intervention, policy makers have moved to curb bearish bets against the yuan and tighten restrictions on the flow of money across the country's borders. Those measures have fueled doubts among global investors about the ruling Communist Party's commitment to give markets a central role in the world's second-largest economy and make the yuan an international currency.

"They're trying to drive a car with one foot on the brake," said Mr Hart, who estimates the People's Bank of China spent more than US$100 billion supporting the yuan in onshore and offshore markets during the first 12 days of January.

"If China were to devalue to a level that wasn't actually a true equilibrium they will get run over pretty quickly, they will blow through FX reserves, and then they will lose face because they'll be forced to devalue."

While a one-off drop in the yuan could ease selling pressure on the currency and support exports, it would also entail risks for China and the rest of the world. Chinese borrowers have amassed US$1.5 trillion of foreign-currency debt, according to an official estimate at the end of September, which would become instantly harder to repay after a sharp decline in the yuan.

A devaluation could also fan fears of a global currency war - a risk that Mexico's finance minister cited earlier this month - and spur the US Federal Reserve to backtrack on plans to raise interest rates, according to Mr Hart.

Chinese policymakers have signaled there are no plans for a big drop in the yuan. Premier Li Keqiang on Friday pledged a "stable" exchange rate and said the nation has no intention of stimulating exports through a competitive devaluation. Bets against the currency will fail and calls for a large depreciation are "ridiculous" as policymakers are determined to ensure stability, Mr Han Jun, the deputy director of China's office of the central leading group for financial and economic affairs, said last week in New York.

China's currency, which traded at 6.5793 in the onshore market at the 10.43am in Hong Kong, will end the year at 6.7 per dollar, according to the median estimate in a Bloomberg survey of analysts. Rabobank, which has the most bearish forecast in the survey, predicts a 13 per cent drop to 7.6.

There is a precedent for a sharp devaluation. The currency slid 33 per cent at the start of 1994 as authorities unified official and market exchange rates, and the yuan has stayed stronger than that level ever since March of that year. That decision was a "wild success," helping to set the stage for years of economic growth and foreign-exchange inflows, said Mr Hart, who founded his hedge fund in 2001.

While a devaluation this year would be "jarring" and may initially accelerate capital outflows, it would ultimately put China in a stronger position, according to Mr Hart. He said the country could explain the move by saying it would put the yuan at a level more reflective of market forces and allow the currency to catch up with declines in international peers.

Despite recent weakness against the dollar, the yuan has gained 36 per cent over the past decade against a Bloomberg basket of 13 currencies designed to replicate the official CFETS RMB Index. The gains have come even as China's economic growth dropped to the weakest annual pace in a quarter century last year.

Mr Hart started a China fund in 2009 to bet on the country's economic slowdown, telling a conference in New York two years later that he was wagering on declines in the currency. While he may have been early to enter that trade, some of his past forecasts have played out. Mr Hart handed investors a six-fold gain by betting against US subprime mortgages before the global financial crisis, and profited in 2010 with wagers against European government debt.

He is not the only hedge fund betting against the yuan. Carlyle Group's Emerging Sovereign Group in New York and Omni Partners in London are also positioned for a retreat in the currency. Mr Crispin Odey, who runs Odey Asset Management, said in September that the yuan should fall by at least 30 per cent.

Mr Hart said he is wagering against the currency with put options, contracts that provide the right to sell at a specific price within a set period. Bets on a sharp devaluation aren't common among his hedge fund peers, who only recently started to wager on a gradual depreciation, Mr Hart said. He did not respond to a Bloomberg News request for additional information.

"It strikes me as odd that the world would assume that China wouldn't pursue the same type of monetary policies" that led to weaker exchange rates in other nations, Mr Hart said. "They're between a rock and a hard place."