The Impossible trinity (also known as the Trilemma) is a trilemma in international economics which states that it is impossible to have all three of the following at the same time: a fixed foreign exchange rate, free capital movement (absence of capital controls), and an independent monetary policy. From time to time, the People’s Bank of China (PBoC) have attempted the trinity but only for a short period of time or by keeping one relatively fixed.

Currently, the People’s Bank of China (PBoC) is going through another trilemma crisis. It is faced with a steady decline in the yuan exchange rate against the dollar, increased upside pressure on interest rate and outflow of hot money from the economy. The drain of PBoC’s forex coffer indicates that the central bank has been trying to popup the currency against the dollar or at least smoothening its decline. As of now, the yuan is trading at 6.94 per dollar as the PBoC is aggressively defending the 7 per dollar level. The central bank is also trying to control the domestic interest rates, which are facing upward pressure. In Hong Kong, the interest rate on yuan is already in double digits and heading higher. To reign on the exchange rate decline, PBoC has pushed liquidity to such levels that there is a crisis of domestic liquidity. Over the past couple of months, PBoC’s liquidity draining operations have led to the freezing of the repo market quite a number of times. In addition to that, PBoC has imposed additional regulatory paper works on offshore mergers and acquisitions as well as on retail purchases of foreign exchange.

Though PBoC still has lots of resources such as $3 trillion forex reserves and positive current account, we suspect the central bank would ultimately fail to reign on either interest rates or exchange rate or both.