China faces a new currency weakness as the threat of a deflationary economic collapse lingers, and a slump in the real estate market prompts foreign investors to withdraw money.

The latest steps taken by the Chinese government to address this issue pose downside risks to Bitcoin (BTC) through foreign exchange channels, according to one crypto watcher.

China’s measures may lead to a stronger dollar

The tightly controlled Chinese yuan (CNY) depreciated by 1.39% against the US dollar, while the offshore yuan (CNH) depreciated by 1.25%. China’s benchmark stock index, the Shanghai Composite Index, fell more than 7% to its lowest point since March 2020, according to TradingView data.

The People’s Bank of China (PBOC) loosely pegs the renminbi’s value to a basket of 24 currencies through a managed floating system, allowing it to fluctuate by 2% above or below a daily published benchmark.

China’s state-owned banks sold US dollars onshore and tightened liquidity in offshore foreign exchange markets on Wednesday to support the yuan, Reuters reported. The one-week Hong Kong interbank offered rate, a gauge of offshore yuan liquidity, rose to 4.95045%, its highest level since September 26.

These actions could lead to a broadly stronger U.S. dollar, tightening global financial conditions, and reducing investors’ exposure to risky assets such as Bitcoin and tech stocks.

As the People’s Bank of China sells US dollars domestically to support the renminbi, it also buys them against other currencies to stabilize the US dollar’s share of foreign exchange reserves. All else being equal, this intervention could boost the dollar index, which measures the dollar’s value against major currencies.

Bitcoin has an inverse correlation with the dollar

Bitcoin is known to have an inverse correlation with the US dollar. Bitcoin’s 50% surge in the fourth quarter of 2023, driven in large part by optimism about physical ETFs, comes amid a 4.5% decline in the dollar index.

“Big state-owned banks today sold dollars to support the renminbi, and the It was observed that lending was reduced to tighten original liquidity and raise short selling costs.This is due to the dollar being bought back against other currencies to maintain the foreign exchange reserve ratio. “This typically leads to broader dollar strength.”

Furthermore, “China has an incentive to keep Bitcoin’s upside capped in order to maintain a relative veil of currency stability and prevent capital flight. Past episodes when the renminbi came under pressure , which is consistent with Bitcoin’s poor performance.”

The dollar index is already up 1.8% this month. Meanwhile, Bitcoin fell 4% to $40,500 after hitting a high of around $49,000 earlier this month.

｜Translation and editing: Rinan Hayashi
｜Image: Li Yang / Unsplash
｜Original text: China’s Currency Woes to Weigh on Bitcoin: Crypto Observer