When everyone thinks the dollar will fall against the yuan, then the incentive to short the dollar is huge. Thus it’s no surprise that Chinese dollar loans (effectively a short dollar position) have soared 40% year over year to $360 billion, as shown by Bloomberg below. Meanwhile dollar deposits (effectively a long dollar position) are falling.
While the yuan seems most likely to strengthen against the dollar over the long-term as China develops, it’s worrisome that nearly everyone holds this view, especially in China. It’s one thing to be long the yuan because you hold yuan, but it’s far more speculative when you’re taking out dollar loans as a bet. Should the dollar surprise, and actually strengthen substantially against the yuan, these $360 billion in Chinese loans would suddenly be a lot more in yuan-terms. Chinese debtors would end up being far more leveraged than they thought.
Is it a base case scenario? No. It’s an outlier, but should it happen, a huge amount of yuan speculators would be annihilated.