This information involves the secret ‘Shanghai Accord’ reached on the sidelines of the G-20 central bankers meeting in Shanghai, China, on Feb. 26.
The situation confronting the central bankers was the following: China needs to devalue its currency to rescue the Chinese economy. But the last two times China devalued against the U.S. dollar (August 2015 and January 2016), the U.S. stock market sank like a stone. This threatened to set off global financial contagion that could lead to a repetition of the 2008 panic, except worse. The challenge was to find a way to give China some currency relief without igniting a global stock market collapse.
The solution is to recognise that the US dollar and the Chinese yuan are not the only two currencies in the game. China has a larger combined trading relationship with Japan and Europe than it does with the U.S. The secret plan devised by the central banks has three parts: Tighten in Europe and Japan, ease in the U.S. and maintain the U.S.-China peg.
By maintaining the US-China peg, markets would not panic about Chinese devaluation. In fact, by easing the US dollar, China could ease the yuan and still maintain the peg. It’s just a case of follow the leader.
Voilà! The Chinese got currency devaluation, and the world hardly noticed.
How do we know this? After all, this plan was never publicly disclosed.
The secret summit took place on 26 February. Our hypothesis was that a plan to give China some relief was on the front burner. What subsequent facts enabled us to update the hypothesis (as Bayes’ theorem requires) to confirm or contradict the hypothesis?
We used the following:
From an analytic perspective, the case is overwhelming. We had four powerful confirmation points and no contrary evidence. The odds of these four critical events happening in a short time frame without coordination are miniscule. The odds in favour of the existence of the Shanghai Accord are high. There has been no official denial.