Is the renminbi undervalued or overvalued? The answer, strangely, is "both". China's uniquely closed capital account puts currency markets in a unique state of disequilibrium, allowing the renminbi (just like Schrödinger's famed cat) to be both undervalued and overvalued at the same time.

On the one hand, the renminbi is clearly undervalued on standard BOP metrics. With sharply rising external trade and current account surpluses, there's little doubt that the renminbi is facing significant appreciation pressures on a current flow basis.

However, it is also heavily overvalued according to monetary balances. A decade of dramatic money growth at home and a quasi-fixed exchange rate have meant a massive build-up of local liquidity behind China's capital walls - putting huge depreciation pressure on the renminbi if convertibility restrictions were ever lifted.

And this bizarre state is absolutely key to understanding Chinese currency policy, i.e., why the authorities are like "deer in the headlights" when it comes to renminbi issues, with no good choices other than to (i) keep the exchange rate basically stable and (ii) keep tightening capital controls.