Yuan a know something?

August 14, 2015

“It doesn’t matter what the Americans say, what matters is what the Chinese do”, is what I said to a friend early on Tuesday, in reply to his question about remarks made by Fed deputy chair Stanley Fischer and carried in the media on Monday night (Israel time).

I was paraphrasing Ben-Gurion’s famous statement that “our future is not dependent on what the goyim say, rather on what the Jews do” — and I had in mind a general assessment of the global economy, rather than anything specific. Without doubt, the country that has exercised the greatest influence over the world economy, at least since 2008, is China. The fact that the Western-oriented, self-obsessed media of America, Europe and Israel remain mired in an obsolete, Occidental view of the world is most unfortunate, but it cannot change the reality that China is pro-active, while America is reactive — and Europe supine.

In any event, that conversation took place before I caught up with the overnight news from China: the Chinese yuan had fallen by almost 2% versus the US dollar. Given the degree of volatility now commonplace in all the main markets, a 2% move does not sound like a lot and, at first, the headlines were not dramatic.

 “Once-in-a-decade”

But analysts in Asia and those whose job is to rise early in Europe to comment on the Asian markets, had no doubts or illusions as to the importance of what had just happened. “It’s one of those ‘once-in-a-decade’ moments”, was how David Simmonds, the senior currencies analyst at Royal Bank of Scotland in London and a veteran Asia-observer, headlined his note to clients that morning.

As the magnitude of the event gradually sank in, markets began to tank, first in Europe, then in the US. Wednesday saw a massive sell-off in Asia and further sharp losses in Europe, but the US markets reversed course at midday, after Europe closed, and recouped their morning losses. By then, everyone had finally grasped that something very big had occurred — even the mainstream media gave the yuan front-page play on Wednesday.

But what was — and is — all the fuss about? Let’s start with a correction: the Chinese yuan did not fall on Wednesday. It was pushed. Like everything else of importance in the Chinese economy, the exchange rate is strictly controlled by the central government. The correct formulation, therefore, is that the Chinese yuan was devalued by 1.89% on Tuesday. It continued falling, this time under enormous pressure from the markets, on Wednesday and Thursday, with the Chinese central bank, the PBOC, intervening on Wednesday to support the yuan, after the extent and/or pace of the fall was apparently deemed “too far”, or at least “too far, too fast” by the authorities.

The bottom line is that over the three-day period of Tuesday-Thursday, the Chinese government engineered a devaluation of 5% in the Chinese currency. To provide perspective, let’s note that Tuesday’s 1.89% drop was, by itself, the largest one-day fall in the yuan/dollar rate in 20 years. That’s why experienced traders and analysts were so electrified by that event — which the PBOC specifically declared to be a “one-off event”. Yet no-one believed this, which is why there was such heavy selling of the yuan the next day, forcing the PBOC to intervene again, this time to buy the yuan, not sell it.

The proximate cause for this move may have been the very poor trade figures issued by China on Sunday, which showed exports falling. But these were, at most, the straw that broke the dragon’s back, because they confirmed that the Chinese economy was performing very poorly and that the growth rate was much below the officially-targeted rate of 7% per annum, perhaps nearer to zero than seven. No-one knows for certain and no-one believes the official Chinese data, but among the more reliable Chinese data are those for electricity production, now showing a negligible rate of increase — the lowest for thirty years!

Global currency war

Most of the causes of China’s economic slowdown are home-grown, but the poor export performance reflects both a general economic malaise around the world — and the impact of deliberately engineered devaluations by, inter alia, Japan and the EU, on the competitiveness of the Chinese yuan. Since Chinese exchange rate policy has for many years been to peg the yuan to the dollar, the very rapid rise in the dollar’s value versus the yen, euro and other European and global currencies over the last year has translated into significant and cumulatively increasing damage to the competitiveness of Chinese exports.

China can thus no longer afford to stand by and watch while the yuan’s value rises with the dollar. Instead, it has declared very clearly that it is joining the global currency war and, instead of importing deflation from others via its overvalued currency, it is going to export its own deflationary pressures by devaluing its currency.

The turbulence on the markets is an early expression of the profound destabilization that this change of policy by China will generate. Tuesday, August 11 saw the most important economic event of the year, perhaps of the decade: the beginning of a yuan devaluation. If you missed it, or just shrugged, catch up on it before it catches up on you.

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