The value of the cryptocurrency bitcoin is melting down Thursday, having dropped 20% against the dollar by midday Eastern Time in only two hours of frantic trading.
The move reversed an almost equally feverish rise in recent days that had appeared to be driven by concerns that China will introduce new measures to stop its citizens moving money out of the country. China accounts for over 90% of reported bitcoin trades and around 70% of bitcoin "mining" (the production of new bitcoins through the building of blockchain that makes up the currency's infrastructure). So it's unlikely that the source of recent volatility lies anywhere else.
While it's impossible to pin down the exact source and motive for the bitcoin rally, there are plenty of signs that what's going on with bitcoin is, ultimately, driven by what's going on with China's official currency, the renminbi (also known as the yuan). The renminbi has fallen sharply since November but rallied over the last two days thanks to a brutal short squeeze engineered by China's central bank to put a bit of fear into speculators.
After nearly touching 7 to the dollar on Monday, the renminbi rallied over 2.5% Thursday to reach 6.81 in the offshore Hong Kong market. That abrupt reversal was magnified many times over in a bitcoin market that doesn't have anything like the same liquidity or transparency as the market for official currencies.
By anyone's reckoning, bitcoin was, as the analysts say, "due a correction." It had risen by 45% against the dollar since Dec. 21, and by an eye-watering 521% since September 2015. Those moves are all the more striking because the dollar has strengthened against virtually every other national currency in the world in that time.
The question was, what would trigger the correction? The answer appears to have been a series of nudges and winks from the authorities about the introduction of new capital controls to slow the renminbi's decline.
Over the new year, the People's Bank of China, China's central bank, said that banks will be required to notify it of all cash transactions over 50,000 yuan ($7,100), down from a current ceiling of 200,000 yuan. It said the move was merely aimed at improving the monitoring of money-laundering and tax fraud. Meanwhile, the State Administration for Foreign Exchange (SAFE) imposed onerous new reporting requirements requiring people to explain why, where and how they intend to use their annual quota of foreign currency (which is capped at $50,000 per person).
While Beijing has allowed the renminbi to weaken over the last 18 months, it doesn't want a disorderly rout that would both trigger panic at home and invite fresh accusations of currency manipulation from the new U.S. President.
The fact is, such manipulating as Beijing has done over the last 18 months has been to support the renminbi rather than weaken it. Capital outflows from China in the first 10 months of 2016 rocketed to an estimated $530 billion, while the country's stash of foreign reserves has fallen nearly 25% from a peak of just under $4 trillion in early 2014. Analysts estimate that the PBOC spent over $34 billion in November alone to prop up the currency, and figures expected next week from SAFE are expected to show reserves dropping below $3 trillion for the first time since 2011.
Chinese bets against the renminbi have snowballed since Beijing let it fall by 2% against the dollar in August 2015, the first revaluation in years. And, as this chart shows, the renminbi and the bitcoin rate to the dollar have become increasingly closely correlated (though bitcoin's rise, in percentage terms, has of course been far more dramatic).
Today, once again, that correlation was affirmed, dramatically. If ever China actually tries to close down bitcoin exchanges as a form of capital control, the fallout will be truly exciting to watch.