Yuan Devaluation

Water Cooler Investing
#1

Anyone with any insight into how bad this is going to get, or any opinions on how this isn’t the beginning of the end for the US economy?

Yuan devaluation is going to directly harm both Japan and Europe, who are attempting to revive their economies through the same tactic. In turn, most of the EM markets are going to have to follow suit to keep pace with China, or risk seeing their export demand decline rapidly.

I would assume the ECB and the Japanese Central Bank respond with further easing measures to offset the effect.

All of this leads to further appreciation of the US dollar, further import deflation, lower interest rates and further deterioration in US manufacturing and exports.

A further rise in the dollar is bearish for oil, that’s not going to help EM. To top it off most contries are already in debt up to their eyeballs, so mass fiscal stimulis like '08/'09 must be out of the question for most.

Someone talk me off the ledge…or give me a push i guess.

#2

There are definitely clear problems, but you’re a little late to the party and overly hyped with these worries. The devaluations have been relatively small (and expected for more than a year) and even if other nations’ join in, the world doesn’t fall apart. The expectation of Chinese deported deflation via these moves and the relative strenghtening of the USD is one thing that held off the rate hikes for so long. Beyond that, the US 1) is primarily a service economy with exports totaling 15% of GDP, so the impact of a strong USD is marginal to growth, 2) US manufacturing is more value added based than that of China so we don’t necesarily compete primarily on price and 3) there are positive impacts, such as widening corporate profits, which have been demonstrated by the gapping out of CPI vs PPI after moving in tandem for decades. This widening of margins has already been taking place for about a year and is demonstrated in earnings resiliance despite the top line pressures that have been seen.

Europe may see some pressures of their own, but again there are benefits to the currency changes that they experience as well. Many of their exports such as those of Germany also compete in the value add category, so again price is not the only factor. Not many people are going to pass up their Mercedes, Porsche, Ferrari, Lambo or BMW for a JAC motors because it’s suddenly now more cheap.

With respect to the emerging markets, they do need to devalue to a point to keep pace and they are in trouble, but they also supply China for the most part rather than compete with China. So devaluations may not need to be competitive and most of what they sell (commodities) is already priced in USD anayways.

I mean, you’re right to be concerned, I just don’t understand the frantic nature of the post. These issues have been discussed ad nauseum over the past 2 years and are well known and tracked in todays markets.

#3

My concern is that the movement will be larger than the market has been anticipating and up until this summer the US and China bore this burden together, which would not be the case moving forward.

I agree, the movements that have occured to date are not significant. What I find concerning is that the pace is quickening, so I’m curious to know where this ends. If the ceiling is at 6.7 Yuan per US Dollar, this is a non-issue. If we’re headed towards 8 Yuan per Dollar, I would say that the market is not anticipating this at all. Any insight into what the PBOC might see as a hard ceiling?

The euro depreciated by 25% since mid 2014, same with the Yen. A 20%+ move in the Yuan is not implausible.

Prior to the Yuan devaluing, both the US and China held the burden of a strong currency and both were importing price deflation. When China decouples its currency from the dollar, the US is on its own in this reguard and China only exxacerbates this issue.

I definitely agree that the devaluation of the Yuan in August held the Fed from raising rates until December. That move was small relative to what has occured over the past two weeks. By that logic, the Fed will be forced to delay their next hike, no?

I’m not very knowledgeable surrounding the makeup of US imports/exports, but I see that nonfuel imports have declined steadily since mid 2014. Its not a coincidence that this is the same time that the US dollar started appreciating relative to major currencies like the Yen and Euro. Again, my concern is that this has occured while China’s currency was in lockstep with the dollar, not moving against it. A large devaluation with the Yuan will support the trend of further import price deflation, especially if it sets off another round of devaluations in Europe, Japan, EM, etc.

Again, I’m not very knowledgeable about global trade, but I think you’re oversimplifying the significance of competition with China. China must compete with someone with their exports on the basis of price, right? If the US doesn’t compete because we’re mostly value-add, same with Europe…and EM just supplies China…we’re insinuating that there are no losers here. There will be some markets more harmed than others, but a weakening of the Yuan will do significant damage to someone. Not that I have any clue who they is, I only imagine that those countries will immediately respond with similar devaluations.

So, my concern is that currency devaluation is not a win-win event. Anyone who is on the losing end can pass the buck by matching that devaluation. If the only area of the world not devaluing is the US, that makes the US the clear loser in this scenario as imports rise, exports fall, inflation falls, the Fed is forced to significantly change their rhetoric and expectations for future rate hikes and the strong US dollar continues to be a headwind for global commodities.

I see the market down significantly today, long intrest rates are down, commodities are down and the Yuan had another big devaluation. I’m not sure I’ve missed the party, it seems to be going strong right now.

#4

I mean, people in the markets HAVE been discussing 20% devaluations in the Yuan for at least the past six months. I just don’t see it as a world ending or necessarily market crumbling event.

I actually do work a lot in the import / export and global trade sectors. I cover commodities, sovereigns and industrials. You still have yet to show how a strengthening dollar majorly hurts a consumer and service based US economy which is only 15% export based and now gets its imports at a discount. Again, look at the widening of corporate margins alongside the CPI - PPI differential. When you make that link to the US GDP you may have a better point.

Sure there will be countries hurt by this and there may be further volatility and downside through 2016. I’m in cash in my 401k because I’m ultra conservative. I also started the week off with a 9% gain in my personal account on the triple short EDZ ticker, which I closed out that day. But the MSCI EM index is already down 36% since 2011 on these well known concerns. You’re also really making some wildly inaccurate points that show you don’t understand the global flow of trade and undermine your stance as well.

I’m not saying there isn’t a very strong chance of a down leg at some point but your inevidatable apocalyptic scenario is just silly. Let’s take another look at China. Their GDP is now about evenly split between manufacturing and services. Manufacturing is in the dumps, but retail sales (consumer / services) have been growing at a 10-12% year over year pace for the past six months or so. The savings rate there is also almost 30%, so there is a strong pipeline and room to run in terms of expansion in the retail sector. That’s a silver lining no one seems to want to talk about. If you want to have a mature analysis, you have to look at both sides and have a profile of the situation based on reality, not the FOX doom room BUY HIGH SELL LOW mentality.

#5

Not sure what’s apocolyptic about anything I’ve said but clearly I’ve upset you, my apologies.

If the yuan were to devalue by say 20%, why would any country that is currently pursuing similar policies not echo that move? Japan, for example, being a major trade partner with China isn’t going to simply allow the Yuan to depreciate to the Yen. They already have enough issues without giving China a competitive advantage.

I think that gets at the heart of my concern. Why would any country that is currently experiencing growth problems not respond with a currency devaluation of their own?

#6

Well, for starters, the Yuan is planning to shift its pegged rate to a currency basket including its primary trade partners (the Yen, etc) so any move to devalue relative to it will be somewhat self defeating.

Secondly, what is the harm to global demand? You keep alluding to this, but I’ve made a strong point that it actually boosts US profits and aggregate US demand. It will also bring capital inflows to the US markets as a safe haven (we’ve seen this demonstrated as well). So other than causing distortions in foreign markets, what is the real economic impact? Yes, this may cause some pain for emerging markets, but not so far beyond current expectations if you focus on the underlying changes to economics. I got short because you asked for a counter argument and I gave you one. Then you basically said you weren’t familiar with global trade flows, ignored it, and essentially repeated it without addressing the central point I made about examining the actual economic linkages to aggregate demand and flows.

#7

Another issue is that in an economy with a fixed exchange rate, attempting to pursue expansionary monetary and fiscal policies at the same time may actually wash one another out. China may be forced to choose between two of the three between controlling their spot rate, expansionary fiscal policies and expansionary monetary policies.

#8

Too much to type and too many questions, so pardon me for switching the conversation here a bit.

If I’m understanding your logic, China benefits by exporting more goods to the US while the US gets cheaper inputs. With cheaper inputs, profit margins rise here in the US. In China, stronger export demand drives revenue growth in their struggling manufacturing sector. Imported deflation from China, in the form of cheaper goods, keeps US inflation low. Further downward pressure on inflation will provide more reason for the Fed to slow or hault their planned series of rate hikes. Low inflation, low interest rates for longer and high margins are all bullish for the US market. I think I’ve got that right, but let me know if I’ve got any of that wrong.

Two questions I have about that:

Should we not be concerned, given our low inflation rates, that additional imported deflation will spark deflation fears?

Given that the Chinese are devaluing against that basket of currencies, rather than directly targeting USD:CNY, shouldn’t we be concerned that others will do the same (devalue broadly, rather than directly vs. the Yuan) in response to Yuan devaluation? The net result being self-defeating when looking at a Yuan:Yen, but would strengthen the USD vs. both. If so, would that not contribute to further imported price deflation?

#9

Sounds right.

Deflation was and is a real concern. The two mitigating factors at this point are nearing full employment bouyed by strength in the consumer / service sector and the expectations that the commodity price slide will likely begin to reverse course as adjustments begin to take hold and demand slowly improves. Overall, you are right about the price deflation argument, which is one that I worry about. A host of others, from Bill Gross to Soros have commented on it as well.

In addition to the mitigating factors I listed though, the effects of a devaluation will be partially muted by the fact that service and consumer sectors (which dominate the economy) are less sensitive to import prices and the fact that most commodity producing emerging markets feed the Chinese manufacturing so they are more focused on thet Yuan / domestic rate. They also have to balance their desire to devalue to shore up demand against higher financing costs for foreign denominated debt and further foreign capital flight that will occur with devaluations. So the race to devalue does have other factors besides demand to take into account.

My point isn’t that there is no risk, but that it’s hard to look directly at the current environment and jump conclusively on either the bull or bear wagon. I expect a lot of pain in emerging markets and I expect the credit losses and turmoil there to be worse than the current market expectations, particularly in China. But I also expect it to be a volatile ride with relief rallies in between shaking up the short positions, particularly withi valuations already pretty beat up in the emerging markets. I also think there’s some downside to the US (why I’m in cash) but I think you have to be balanced in that view. I’ve felt this way for awhile, but the last three months produced a strong US rally, so I think it’s important to stay nimble and open minded but ready for a potential drop. Despite all that, I’m unsure on the magnitude of the drop in the US, particularly if capital comes in from foreign markets. These things tend to take longer to materialize than people expect and then occur very suddenly.

#10

Yuan devaluation is incredibly bad for the rest of Asia who competes for much of the same export business. although China is increasing the complexity of its manufacturing business, it still produces a lot of garbage that is now also produced in places like Vietnam, Cambodia, Laos, Bangladesh, Indonesia, the Phillipines and Pakistan. if China devalues, they help retain current businesses in these industries but also attract new investment away from these countries. these countries cannot devalue as easily as China because most of them have virtually no net foreign-exchange reserves while China has near infinite. these countries need to keep interest rates high and currencies stable to attract capital or else they could lose control of their currency. China can set the x-rate at whatever they want for decades without losing control. China, Japan and South Korea, all of which have near infinite foreign-exchange reserves have been in a futile currency war and fight for capital since 2011. China instigating a currency fight with lesser Asian countries who can’t defend themselves makes sense if they’re trying to prevent an internal financial crisis.

for an example of what happens when a rapid Yuan devaluation occurs, look to the 1997 Asian Financial Crisis. China and Japan didn’t take the brunt of it. why? foreign-exchange reserves and less reliance on foreign investment.

#11

[quote=“Black_Swan”]

not sure i agree here. you are assuming that the U.S. savings rate goes up. if even some of the savings from the purchase of foreign goods is spent on domestic goods, the bulk of which are purchased using leverage (e.g. houses, autos), then credit growth could rise and the price effects could actually be positive.

#12

I agree with some of what MLA’s saying in his first post but would add two points to clarify.

  1. Earlier, when I said other EM countries feed China with commodities, I’m looking at South America, Indonesia and the Australia (Not EM, but still). Other Asian mfg countries are in competition and may devalue in turn, but that would be more of a regional issue. Japan however, manufactures more value added as does S Korea, so I don’t see a Yuan devaluation as hurting them to the same degree.

  2. To clarify about devaluation and foreign reserves. To devalue the Yuan, China has traditionally bought foreign currency and added to its reserves. Lately, to support its peg against the USD which has been strenghtening, they’ve been forced to burn through reserves to buy up Yuan. So, I’m not sure why MLA is saying you need reserves to devalue I think he may have that one backwards. In fact, one of the major drivers behind the Chinese decision to devalue and shift to a currency benchmark basket has been to ease the pressure on their foreign reserves from having to keep up with the rising dollar. Since June, they’ve been burning through an average of $51B a month to maintain their tie to the appreciating USD.

One other point I’ve made in that regard is that China’s reserves are not infinite. At $3.4T, they’ve already fallen by 15% in a year and a half without major stress. In a high stress environment where they were forced to support their currency (keep it from devaluing), they could easily burn through $200-$300B a month. Couple this with any reserve funded stimulus or capital injections while realizing you don’t want to go near zero in the reserve account and it quickly becomes a large but very finite number. Even at August’s elevated burn rate of $94B per month leading to the devaluation, their current reserves would only last three years. But if you set a minimum reserve requirement of about $500B, it shortens that number.

#13

I’m not sure I follow the link between saving on imports and then spending beyond the savings level on domestic goods, which is what would mathematically be required to push up consumer leverage.

#14

Huskie, this should really add some light to the devalation. Countries use their FX reserves to support (strenghten) their currency and increase them to weaken them. So over the past decades, China accumulated a peak of $4.0T in FX reserves in June by weakening their currency. That number is now $3.3T as they’ve burned through $0.7T trying to strengthen it to hold its peg against the USD. Today they released the data stating that last month, they burned through a record $108B trying to hold their peg. With this in mind, it makes perfect sense that they weakened their currency recently. In fact, the weakening should really be viewed as letting it float closer to market implied levels as they were fighting the market to keep it stronger. When viewed through that lense rather than the lense of viewing the devaluation as a move to shore up growth or artificially weaken the Yuan, this move is much less negative. It’s funny, because for decades people criticized them for not letting it float and now when they try to let it slide to keep from burning through reserves everyone throws a hissy fit in the markets.

#15

i did exxagerate the “infinite” nature of China’s forex reserves. this morning we know they burnt through $100B in December alone.

you are looking at Yuan devaluation in a normal situation. you have to consider what happens in a crisis situation wherein all of Asia is devaluing and their economies are ramping down. if they face mass Yuan selling from developed markets, which typically happens when you remove a peg and/or rapidly lower interest rates or bank RRRs (which they will be forced to do if the domestic economy is crap), they will need to buy Yuan and sell forex to maintain some control over the currency’s decline. Yuan and EM currency devaluation is only good to an extent. 10-30% devaluation plus much lower domestic interest rates, good, 80% devaluation and higher domestic interest rates to attract foreign capital, bad. China’s high forex reserves gives it more power to ensure monetary stability relative to most of its smaller export competitors. you shouldn’t be using forex to manage your currency. you should be using forex to add stability to your economy whilst using more effective policy tools like changes in interest rates, bank RRRs and removing currency pegs to some degree. any country that has a currency peg and is unwilling to unpeg is just asking for a massive financial crisis as keeping the peg forces you to use your forex reserves, which are your last bastion of hope in a financial/currency crisis.

#16

Yeah, I agree with that. I think markets are getting this one all wrong. They’re reading all of these growth implications into it when it’s as simple as asking, “Would you want to spend $108B a month to falsly appreciate your currency in a weak economy?” It’s also weird that the 10% Euro devaluation and 15% Japanese devaluations didn’t cause a stir but a percent or two on the Yuan and everybody shits the bed.

#17

I just finished loading up on EDC after I posted that at $9.38, we’ll see where this goes.

#18

Haven’t heard from purealpha in like ages. I hope he’s ok. I heard he was managing mafia money.

#19

I’m not super informed on macro these days (will try to get up to speed in Jan this year), but I suspect part of the reason is simply that those other currencies have been more-or-less floating against each other for a while, whereas a devaluation of an essentially pegged currency represents something more fundamental changing. Some investors are just holding to reevaluate what their investment hypothesis will be going forward, and others who have been on the “China can’t lose” bandwagon may panicking.

But yeah, these things are always easier to explain in hindsight.

#20

Thanks guys, I’ve got a better idea of the implications now.

I think the logic I had wrong was that I imagined China’s Yuan devaluation sparking a round of currency devaluations globally, with the net result being a much stronger dollar. In reality, if I’m understanding correctly, a country like Japan will simply attempt to fight off a depreciating Yuan relative to the Yen, but that won’t have any significant effect on the Yen/USD exchange rate.