China's Currency Policies Need an Overhaul

The irony of the yuan rally that took bears by surprise last week was that the surge came just days before China announced that its foreign currency reserves shrank by $41 billion in December. The stockpile is now $3 trillion, a decline of more than $1 trillion since its peak in 2014. Authorities have been drawing upon the huge war chest to temper the yuan's depreciation as capital flowed out of the county amid an economic slowdown and worries over debt levels.

Despite an annual drop of $320 billion, the amount China has at its disposal remains significant by just about any measure. Yet it would be appropriate for investors to start wondering whether the margin of safety is becoming perilously thin. They should also ask at what point the People’s Bank of China would no longer be able to afford to support the currency, which would lead to a much more substantial decline than anyone anticipates.