Beijing needs to stem capital outflows and manage expectations when market jitters risk putting falls in China’s yuan into a potentially destructive feedback loop, a senior Chinese central bank researcher said.
“At the moment, the fall in the yuan’s exchange rate is shaping market expectations. Depreciation triggers capital flight, and capital flight exerts even bigger pressure on the yuan,” said Wang Zhenying, head of the Statistics and Research Department of the People’s Bank of China’s (PBOC) Shanghai Head Office, said.
“Therefore, it’s necessary to break this feedback loop... for example, by slowing capital outflows,” he said.
China has already been stepping up efforts to manage expectations in the foreign exchange market and to tighten control over capital outflows in a bid to ease depreciation pressure on the yuan, which has fallen about 2 percent against the US dollar this month and more than 6 percent so far this year.
The interview was aimed at promoting Wang’s “Trading Economics” theory and newly-published book on the subject and sheds some light on the academic thinking within the PBOC that influences the opaque policy-making process at the central bank.
Wang, formerly vice head of the Financial Market Management department at PBOC’s Shanghai Head Office said the economy and financial markets were unbalanced systems dominated by positive feedback loops that could lead to explosive economic growth or avalanche-like market crisis.
“Under certain circumstances, it is inefficient, and irrational. And when it’s irrational, it can be destructive,” Wang said, arguing it was necessary to stop, or slow, the chain reaction currently taking place in the yuan market.
It was not clear how much support his theory has within policymaking circles, but it chimes with recent moves by Beijing to brake the yuan’s fall.
Wang also used the feedback loop model to explain the boom-and-bust cycle in China’s stock market last year.
“There was a feedback loop between stock price rises, and margin financing. And when such a feedback loop was formed, trading momentum, or a trend, was formed in the market,” Wang said.
He stressed it was important for policymakers to find the feedback loop that determined the overall trend, rather than to seek the simple causal relationship in a complex system.
Wang also cautioned that trade protectionism — as espoused by US president-elect Donald Trump during his campaign — risked plunging the global economy into a similar vicious cycle of protectionism and counter-protectionism.
“The development of the human race is propelled by an increasingly inter-connected trading network. But if we cut the network, the world economy will be separated into isolated islands, and our economic growth will slow down.”
Protectionism by individual countries would then create a “downward spiral” that would result in stagnation and eventually hurt every country.
Wang said “Trading Economics” was the culmination of 15 years of observation and analysis. 
He plans to translate his book on the theory into English next year.

Source: Arab News