Everything has started to go wrong in the Chinese economy despite its mind-bending growth rate of 7%. Exports plunged and imports too. Sales in the world’s largest auto market suddenly are shrinking just when overcapacity is ballooning. The property market is quaking. Electricity consumption, producer prices, and other indicators are deteriorating. Capital is fleeing. The hard landing is getting rougher by the day. But Tuesday morning, the People’s Bank of China pulled the ripcord.

In a big way.

It lowered the yuan’s daily reference rate by a record 1.9%. The yuan plunged instantly, and after a brief bounce, continued to plunge. Now, as I’m writing this, it is trading in Shanghai at 6.322 to the dollar, down 1.8% from before the announcement. A record one-day drop.

The PBOC had kept the yuan stable against the dollar. As the dollar has risen against other major currencies, the yuan followed in lockstep. Over the past week, the Yuan’s closing levels in Shanghai were limited to vacillating between 6.2096 and 6.2097 against the dollar. Over the past month, daily moves were limited to a maximum 0.01%. The PBOC controls its currency with an iron fist.

Hence the shock to the currency war system.

The Nikkei, beneficiary of the most aggressive currency warrior out there, had been up, nearly kissing the magic 21,000 at the open for the first time in a generation, but plunged 200 points in one fell swoop when the news hit. Then the Bank of Japan jumped in with its endless supply of freshly printed yen, furiously buying Japanese ETFs to stem the loss. The lunch break put a stop to all this. Then the Nikkei plunged again. Maybe the folks at the BOJ were late getting back to their trading stations. But now they’re back at work, mopping up ETFs.

“Currently, the international economic and financial conditions are very complex,” a PBOC spokesman explained . “Emerging market and commodities currencies are facing downward pressure, and we are seeing increasing volatilities in international capital flow. This complex situation is posing new challenges,” he said.

The yuan’s “relatively strong” exchange rate was “not entirely consistent with market expectation,” he said in perfect central-bank speak. “Therefore, it is a good time to improve quotation of the RMB central parity to make it more consistent with the needs of market development.” So he said, “Today’s central parity depreciated by about 200 bps. The market still needs some time to adapt.”

Meanwhile, the PBOC would “monitor the market condition closely, stabilizing the market expectation, and ensuring the improvement of the formation mechanism of the RMB central parity in an orderly manner.” Certainly, the market would not be allowed to do anything on its own.

And the devaluation is “a one-time correction,” he added, which everyone believed instantly.

Despite the iron grip the PBOC has on the yuan, it hasn’t abandoned the plan to turn it into one of the IMF’s reserve currencies and into a top trading currency to rival the dollar:

Next, the reform of RMB exchange rate formation mechanism will continue to be pushed forward with a market orientation. Market will play a bigger role in exchange rate determination to facilitate the balancing of international payments. Foreign exchange market development will be accelerated, and foreign exchange products will be enriched.

The PBOC will also “push forward the opening-up of the foreign exchange market, extending FX trading hours, introducing qualified foreign institutions, and promoting the formation of a single exchange rate in both on-shore and off-shore markets.”

And then he addressed the problem of capital flight, China’s foreign exchange reserves having plunged 16% from their peak in June last year. This “increasingly large and volatile cross-border capital flow,” as he called it, would have to be stopped, apparently.

So the PBOC and the State Administration of Foreign Exchange (with the somewhat ironic acronym SAFE) would “strengthen the examination of banks’ FX transactions according to relevant laws and regulations, adopt effective measures to fight money laundering, terrorist financing and tax evasion activities, and improve the monitoring of suspicious cross-border capital flow.”

Ah yes, and the PBOC and SAFE would “severely punish illegal FX transactions, including underground banks, and maintain a compliant and orderly capital flow.”

Not a lot of central banks would say that they’ll “severely punish” anyone, except savers. But you don’t kid around with the PBOC.

The PBOC’s freak-out came after all heck had already broken loose in China over the weekend. Read…. China’s Hard Landing Suddenly Gets a Lot Rougher

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