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.

History

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.