Devaluation of the Yuan

In a move that took many by surprise the Chinese authorities devalued the yuan relative to the dollar by a sharp 2%, characterizing it a “market adjustment”. That explanation is problematic for a number of reasons. China’s economy may be slowing but its exports aren’t. The U. S. trade deficit with China is running at record levels. What’s happening in China isn’t the slowing of exports but the collapse of a credit bubble caused by its own mismanagement.

Here’s the analysis of the editors of the Wall Street Journal:

China effectively devalued the yuan by 1.9% on Tuesday, with the possibility of more to come under a new system of daily fixes. There are three main ways to interpret Beijing’s motivation.

First, China believes the yuan is overvalued compared to the currencies of its trading partners, and the central bank is committed to liberalize controls and allow market forces to play a larger role in day-to-day trading. This is the optimistic reading.

Second, China is a victim of the U.S. Federal Reserve’s quantitative easing, which flooded the world with cheap dollar liquidity and now is poised to spark crises in emerging markets as it raises interest rates. This would mean China is trying to delink from the rising dollar more than it is trying to devalue the yuan.

Or third, Beijing has joined a wave of beggar-thy-neighbor devaluations sweeping the region. This would be the worst news for Chinese and global growth.

Jim Cramer think it’s panic:

Did the entire market come down with a case of amnesia, and forget all about when the miners, industrials and biotechs roared on Monday? Judging by the action on the averages on Tuesday, Jim Cramer suspects that could be the case.

“Last night I tried to be skeptical, if not downright critical, about the rally, suggesting it could easily be repealed as the week went on. I didn’t know it would be repealed immediately,” the “Mad Money” host said.

That’s because Cramer was not expecting that investors would be dealing with a Chinese currency devaluation, which makes China’s goods cheaper to export and U.S. goods more expensive to sell there.

The devaluation shocked Cramer so much that he decided to review what happened, so that investors can be prepared for what is next.

First, China is totally desperate. It is clear to Cramer that the Chinese Communist government is trying to put everyone to work while also trying to stop widespread corruption in business and politics. It tried to fix the issue by exports, but then Europe fell apart. Then it tried infrastructure, but now it seems as if everything it needed has been built.

while Howard Gold observes that the move illustrates why China isn’t “ready for primetime”:

The crash and the government’s stealth nationalization of stock trading`exposed China’s equity markets as government-owned-and-operated casinos driven by reckless, ignorant individual investors just waiting to be fleeced.

MSCI has postponed including China A-shares in its China and broader emerging markets index, largely for technical reasons. Vanguard, which tracks emerging-market indexes provided by MSCI competitor FTSE Russell, is plowing ahead.

Speculation MSCI would add A-shares to its indexes helped fuel the melt-up in Chinese shares, and the meltdown may have been partly triggered by its surprise decision not to, for now.

Sebastien Lieblich, MSCI’s executive director of research who spoke to me from Geneva, wouldn’t comment on that. But he said the delay was caused primarily by feedback from MSCI’s large institutional investor clients on regulatory roadblocks in the Chinese markets.

On reflection I think the Chinese have been planning this move for a long time. Since the start of the year they’ve been on a Treasuries selling spree. Getting the best price they could while they still can. For the last couple of months they’ve been buying enormous amounts of oil. Now that their tanks are full they’re ready to devalue the yuan against the dollar, presumably hoping that once again the U. S. consumer would restore their economy’s fortunes.

Not only do I not think it will not work this time I strongly suspect it will provoke a reaction. The U. S. economy is edging towards recession. Expect some screaming from the EU and Brazil.

15 comments… add one
  • Andy Link

    I think it was the Chinese Foreign Minister I heard on NPR today who claimed that we should be happy because this is China moving to a more market-based currency valuation. Hilarious!

  • Hmm. I’d think that if your objective were to have a market-based currency you might want to think of having a fully convertible currency. Maybe not.

  • ... Link

    Jim Cramer thought Lenny Dykstra was a great investor, so I discount his opinions heavily these days.

Leave a Comment