China's currency is set to fall sharply in 2017, triggering turmoil in global equity markets and causing huge pain for commodity-dependent countries such as Australia, according to leading Beijing-based research analyst Anne Stevenson-Yang.
"The drama for the Chinese monetary managers is the situation with the currency," she said in an exclusive interview with The Australian Financial Review.
"They tried hard in 2016 – and were successful for a time – in fostering the expectation that the exchange rate might bounce up and down and that the economy had bottomed.
"But now there's nobody who doesn't think the yuan is going to depreciate. And if there's an expectation that the currency is going to continue to fall, everyone is going to continue to try to take their money out."
Stevenson-Yang, a co-founder of J Capital Research, said that if economic growth were more robust, China could continue to run down its foreign currency reserves to zero in order to defend the currency.
"But that's clearly not what China wants to do, so letting the currency float is inevitable."
Problems with a float
She added that China was reluctant to allow the currency to float for several reasons.
"It would destroy the Chinese economy's chances of growth, and growth is very important politically. It would crash stock markets internationally, and it would destroy the commodity economies – it would have a lot of ugly effects.
"But I do think that it is inevitable. And the currency will float down to 10 or so to the US dollar when the time comes [the yuan is trading at just under seven to the US dollar]. And this will cause a nasty reaction in markets."
Despite the shockwaves a sharp fall in the yuan will trigger, Stevenson-Yang said that a steep depreciation was likely to occur this year. She noted that Chinese authorities had tightened domestic monetary policy in an attempt to stem capital outflows, but that tighter liquidity had led to a spike in corporate defaults.
"I don't know what other options there are. They basically have the choice of allowing the yuan to fall, or to allow defaults domestically.
"Defaults have been increasing because of China's attempts to tighten monetary conditions. But once they let the currency float, they'll be able to flood the economy with cash and avoid defaults."
Forced to shrink
Stevenson-Yang said that Beijing's decision to float the currency would have major ramifications for commodity exporters, such as Australia.
"The yuan will go way down before it corrects. How much iron ore will Chinese steel producers buy if it becomes 20 to 25 per cent more expensive to buy, especially since the steel industry is already losing a tonne of money?"
She predicted that the Chinese steel industry eventually would be forced to shrink.
"Ultimately, Chinese steel output will fall back to 2008 levels, so that it will produce 550 million tonnes of steel annually, instead of 800 million tonnes," she said.
"And that will be a big shock to Australia. Nobody wants that to happen, particularly not China. But, ultimately, it has to happen."
Stevenson-Yang said that China's tighter monetary conditions were already being reflected in a steep slowdown in the country's property market.
"You have to remember that in the primary market, large developers aren't permitted to go bankrupt. It's always in their interest to freeze sales, rather than to sell at lower prices. And in the secondary market in the big four cities, people hold on to their properties because they notice that prices in the primary market aren't dropping.
"So what happens when the public view of housing prices is negative is that markets freeze, and that is what is occurring now."
Steep fall repercussions
Stevenson-Yang said that when the Chinese currency depreciates "it has to fall quite a bit in order to impose such a big cost that people decide that it's better to hold their money domestically".
"There are a lot of people sitting on property they haven't sold, or who have sold and have their money in the bank. Or they're in Canada or Australia and haven't changed their money yet, because they're satisfied with the returns on their investments in China.
"But if they see the exchange rate falling sharply, they'll panic and try and get their money out. And that's why the yuan will overshoot on the downside."
Is Stevenson-Yang worried that US President-elect Donald Trump's hardline stance on China, including his threat to label the country a currency manipulator, will prompt retaliation from Beijing?
"It's very hard to say. I always figured what would happen was that China would wait until after the [January 20] inauguration to bribe Trump.
Bribing Trump
"For instance, [Chinese banking giant] ICBC is the biggest tenant in the Trump Tower, and they could double the tenancy fees. Or else they could offer him a couple of hotel deals.
"And within a few weeks of the inauguration, mainland China would be Trump's best friend who could help solve our infrastructure problem by investing in US public/private partnerships."
But, she added, "the problem is that Trump doesn't understand US international relations, and he might have stumbled into creating problems that he may not be able to retract from".
