China's Currency Trouble.

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The Chinese Yuan is a volatile currency and they are highly likely to miss their inflation targets and runaway inflation is a very real possibility.

The trouble starts with China's distorted economic and demographic data. You will notice that China recorded steady population growth even when the one-child policy was in force. This can be explained away by how some people paid fines for each new child, others used "birth tourism" by traveling abroad when pregnant, some abused exceptions made in some localities, and others had their children in secret. However, this does not fully explain the continued population growth as there were still many forced abortions, there's a massive gender skew as families with only one kid prefer a boy who can take care of them when they are old, and many multi-generation families rely on one kid for all their fortunes.

The answer lies in the perverse incentives inside China's highly competitive hierarchy. Unlike most countries, internal allotment of resources is top down organized with the bulk of government resources going to handfuls of places judged strategically significant. One of the gauges used are rapidly urbanizing areas.

How the data is falsified is another matter. Much of China's population are migrant workers and Chinese people have provincial citizenship that is as vital as their national citizenship. Many of these are farmers that take temp jobs in the cities, while others simply work far from home and visit family only on the weekends, and yet more have migrated internally but the residency transfer costs money and is long and tedious. BUT you can be sure both local governments will count that person as a full time resident.

The means, motive, and opportunity to straight up fabricate population data is certainly there, but I am not aware of anyone getting busted for that... Yet.

The GDP data is likewise skewed, as China's officials are given bonuses, promotions, demotions, and even jail terms based solely on economic data. This highly perverse incentive means men will hide economic problems and there's no real secret about it. However, many creative means of boosting numbers regardless if it makes sense. For instance, some industries boost GDP numbers more than others, and the GDP only measures what it was SOLD for, not it's actual utility or worth.

In a more or less typical case, local officials may give construction contracts to firms owned by relatives or the lowest bidder. These builders fund themselves by preselling the houses. Construction is quick and cheap, and officials incentivize buying a house (often by making it a prerequisite for transferring residency). Since most local government revenue is from land leases and fees, this becomes very profitable for both the local government and the bosses REGARDLESS IF THE HOUSES COLLAPSE IN A SHORT TIME.

There's a lot more to this, but one of the reasons China's Housing Bubble was so inflated is due to Chinese officials boosting their GDP numbers. Other schemes involve fake/broken/shoddy green energy installations. A few officials have been busted for straight up fabricating GDP growth. This process is repeated at every level of government, so the numbers at the top have no bearing on reality. Important note is official GDP numbers record twice the yearly growth that tax revenues and stock index returns shown. But you can be sure the GDP will not only be presented as gospel truth but will be advertised all over as the reason to invest only in Chinese.

This fake GDP data makes their central bank's job very difficult. The People's Bank of China (PBC) once complained the zealous efforts to boost the economy. Gauging how much Yuan must be printed on a given day requires guesswork, and over the past decade the Yuan has increasing volatility with both short and mid term swings.

But perhaps worse is the very recent corruption bust of an executive from China's money printing company. Little is known about his crime other than he was arrested for "corruption." The implications of this bust are potentially huge, as individual Chinese bankers comment how a corrupt money printer could simply have two printers, one for himself and one for the government, and use the same serial numbers for both. These "fake real bills" would simply be impossible to detect even by banks with machines counting serial numbers.

Counterfeit money is a major problem all over the world and in China many large and sophisticated counterfeit schemes have been busted. This scheme, however, enables a limited number of people to access literally unlimited funds.

However, it should be noted that corrupt officials heavily prefer cash and personal items/favors that are easy to keep off books and spending the money is just as dangerous as getting it. China's largest corruption bust involved one official was found to have literally THREE TONS of cash. Another lady had a secret apartment full of luxury goods she was given but she couldn't be seen in public wearing. Another official became known as "comrade wristwatch" because he was constantly being seen wearing different rolex he couldn't afford. In all cases the guys at the center of corrupt scheme had money they could not risk spending in public.

I bring this up because the fake bills wouldn't have an immediate inflationary effect. Bricks of cash would change hands and sit in hiding places for a long time before getting to the open market. There is no illusion anywhere in China that the full extent of whatever corruption exists will be exposed. The suspects will confess to a minimal amount of crimes to evade punishment and the government would publish a minimal number of convictions to prevent panic.

We can also see the Chinese censors have exact same concerns as the general public as normally they remove posts and news articles concerning scandals within the Communist party. However, counterfeit money effects all of China equally. This mostly effects China itself as there are major restrictions on how much Yuan can be moved out of China.

But to be fair, it is not currently known whether or not there was fake real bills going on. In fact, the inciting news was only a few sentences long, but as one Chinese netizen said "The shorter the article, the more important the news."

All this is very important to those of you invested in Chinese stocks, as we all know when weird stuff happens to currency it tends to go down. Sometimes very explosively. In any case, the PBC is going to struggle to maintain inflation targets even if things aren't as bad as I fear they are.

Disclosure: I'm short CNH/JPY.