There's a part of China's economy that's making less sense every day

Everything is wacky all around the world.

Investors in the US are scratching their heads because of the resilience of the stock market. Earnings have been crappy for quarters, guidance is equally crappy, and yet, here we are hitting market highs.

It's weird. Some - actually many - are calling it complacency.

In China, another asset class represents this same strange complacency in the face of a crappy situation - the yuan. It has been steadily depreciating for months now, but for some reason its decline isn't translating into currency outflows.

And it's those currency outflows that tend to make the market go haywire. It happened earlier this year when everyone on Wall Street thought it was the end of days.

So the question with the yuan is, how long can it go lower without the world feeling the consequences?

You yuan some, you lose some

Societe Generale's Wei Yao contemplated this weird yuan situation in a note to clients on Monday.

"The new normal over recent months has been gradual RMB depreciation that doesn't create a negative feedback loop involving other currencies or broader market sentiment. This could embolden policymakers to keep pushing the limits of depreciation, especially if speculative positioning stays subdued," Yao wrote.

Basically it's like this: As long as there's no consequence for letting the yuan fall against the dollar, Yao thinks the Chinese government will keep doing it either because they want the currency to find its fair value or because they believe capital controls are working. Maybe both.

There's a built in danger in allowing this to continue: Other countries could start to devalue their currency to keep up with China's. Then we have a race to the bottom.

There's even more risk here, though. Yao also thinks that by continuing to allow the yuan to fall, it will be harder for the government to stop its depreciation when they really want to. She thinks the People's Bank of China (PBOC) will lose control.

And there's another weird element here that doesn't compute for Yao. Despite the fact that outflows have been minimal, according to published data anyway, the PBOC "keeps stepping up capital controls," and she thinks that might mean the PBOC is working harder at this than it wants to let on.

A few things that could happen

So that brings us to Yao's "new risk scenario." It's one of three laid out in her note.

From Societe Generale:

"Scenario 3 (slow and steady move - 20% probability): The current strategy of steady depreciation picks up pace and intervention is used to limit overly destabilizing volatility. The risk to a steady creep higher in USD-CNY is a build-up in speculative pressures and resident outflows that creates a vicious cycle of depreciation."

The other two scenarios include a one off devaluation from the PBOC (that gets a 10% chance) and a faster transition by the government to a free floating currency (70% chance).

The thing is, scenario three is looking likelier and likelier every day this strange depreciation without consequences and without action from the Chinese government continues.

So don't get complacent.