Currently, you can call it Bitcoin.

Bitcoin has risen above $300 on what seems to be mostly Chinese (not European or greek related) panic related volume/inflow.

This makes sense. The Chinese market is collapsing and there is real concern over the stability of the RMB.

Due to the scale of dollar and foreign liabilities in the country, RMB devaluation simply isn’t an option — not without compromising its financial track records on the international stage. The country needs a strong RMB to defend the interests of its wealthiest citizens but it also needs a cheaper RMB to keep those at the bottom of the ladder in jobs.

It’s a classic rock and a hard place situation. The positive feedback loops that were so great on the way up are now turning into a vicious negative feedback loop which can’t be suppressed unless a major restructuring of the economy occurs.

If the RMB remains supported deflation will grip the land. The Chinese miracle (equivalent of their industrial revolution) will be over and we will see 1929 level unemployment and the busting of many RMB capital markets. If it falls in value, the country will see mass defaults on doar liabilities and/or the draining of its foreign exchange reserves.

The Chinese might be quicker to enact big fiscal projects to remedy the situation than the US was, but as a whole even Keynesian stimulus becomes problematic if your country lacks the basic resources to materialize these plans or the credit reputation to keep importing them.

Those with what will soon be overvalued claims against foreigners are unsurprisingly super eager to recycle them into claims arising from someone else’s balance sheet.

Their choice currency (due to ongoing capital controls across most other major currencies ) seems to be Bitcoin.

This may look great for Bitcoin in the short run. But in the long run it’s going to be a disaster.

Why?

Because Chinese RMB is being swapped into Bitcoin at a massively overvalued conversion rate, on the presumption the official exchange rate is sound when really its value is entirely dependent on controlled capital flows.

Note the slippage already appearing. The average indicative RMB USD exchange rate via Bitcoin is 6.31 versus an official rate of 6.21.

That means the US dollar buys you way more RMB via Bitcoin than the official rate implies.

The most extreme slippage via Bitcoin implies a rate of 6.47 (and it has been higher on the day).

Why is this bad for Bitcoin?

Because if the USDRMB rate holds true — as it must, at least until Chinese RMB policy changes or China’s US reserves are depleted, which will be some time — it turns Bitcoin into an outlet for a currency that’s about to take a massive hit. That will inevitably lead to Bitcoin wealth destruction in the long term as people refuse to honour Chinese Bitcoin cashout claims.

What we are seeing currently is a hugely inefficient market running on the assumption that the USDRMB rate is executable. Think of it as giving away shed loads of valuable product and services to countries no-one else considers worthy of such claims.

This analysis leads me to predict the following.

Bitcoin goes up in price as new flows from China provide an overvaluation of Bitcoin in RMB terms which on paper is deemed an arbitrage that calls for a change in Bitcoin’s value against the USD.

But this is a false exchange rate. So the indicative USD value based on Chinese terms remains hugely overvalued.

That suits Chinese money seeking a safe haven. BUT for the valuation to be maintained or even be materialized in dollar terms takes real USD on hand to cash out against.

But the paper profit reality of the situation — the product of hugely asymmetric flows — is missed on US domiciled bitcoiners, who fail to recognize they are only providing dollars to the great Chinese bailout fund, that most rational agents would not be keen to do.

Which leads to the no-hope situation of the second phase of this scenario. Only three potential scenarios can unfold:

1) the Chinese attempt to cash out in dollar terms quickly, thus the value of Bitcoin crashes as quickly as it went up.

2) the Chinese sit on Bitcoin as a store of value but fail to spark any associated boost in economic activity, thus fail to ignite any increase in “dollars in” into the Bitcoin economy, thus the valuation takes about 2-3 months to bust.

3) as the Bitcoin value ascends in dollar terms it leads to even less economic activity because no one will be inclined to spend bitcoin. Dollars into the economy become even more speculative in nature. New suckers enter late into the pyramid. Massive deflation courts the system. Bitcoiners don’t realise the paper nature of their profits and if and when they attempt to cashout against real assets (miners will need to pay for electricity eventually) the whole thing comes crashing down in even bigger speculative style.

There’s also the less likely scenario that people figure out the RMB Bitcoin arbitrage and in Bitcoin begins to trade at a major discount in RMB terms vs what it does against the dollar to compensate. But that would take an understanding of economics, so I guess we can rule that out.