Keeping China’s Yuan Devaluation in Perspective

Keeping China’s Yuan Devaluation in Perspective

August 07, 2019
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Global markets reacted swiftly, but China and its people may suffer more

The Chinese government’s move to push down its currency’s value serves one purpose: It told the world’s stock exchanges to panic, which they did.

The day the Chinese government “announced” their intention, the DJIA dropped 767 points for a decline of 2.67%.

NASDAQ – with its technology companies that would be most hurt by a trade war with China – fell 3.5%. The broad-based S&P 500 shaved off about 3%.

Elsewhere around the globe:

  • FTSE (UK) dropped 2.47%;
  • DAX (Germany) plummeted 4.85%;
  • CAC 40 (France) fell 2.19%;
  • Shanghai Composite (China) lost 1.62%; and
  • Hang Seng (Hong Kong) declined 2.85%

What the Chinese are Doing

The Chinese government devalued the yuan to fall below its 7:1 ratio with the U.S. dollar for the first time in 10 years. A weaker currency (in theory) will soften the tariffs implemented by the United States. 

The worry of course is that the U.S will impose more tariffs, China will respond with more devaluations and investors will see a ratcheting up of the trade wars between the two superpowers – which will then spill over to an already weakening global economy.

While it’s truly impossible to guess the intentions of China’s rulers – and they’re not about to share their plans – the devaluation, “announced” on August 5th, smacks of desperation. 

What it Means

China’s large devaluation of the yuan will make exports cheaper for foreign consumers of Chinese goods, including Americans, but it will also reduce the purchasing power of Chinese consumers, who will likely consume less as a result.

Regardless of the reason – or reasons – for the devaluation, it’s more likely to harm the Chinese economy than it is to help it.  When a country debases its currency, it typically causes economic pain, not economic gain.

For example, in 1997, after keeping their currencies stable for a decade, Thailand, Indonesia and South Korea each tried to devalue their way out of a crisis. “The result was a capital stampede that exhausted reserves and led to high inflation,” according to The Wall Street Journal.  “Domestic institutions that had borrowed in dollars found themselves unable to service debts.  The dislocation damaged exports and their economies.”

Consider some of the potential problems of the yuan devaluation. It likely will:

  • Increase volatility and pressure on the Chinese currency.
  • Discourage foreign investment.
  • Encourage citizens to store savings abroad.
  • Weaken consumer spending.
  • Possibly result in contagion globally.

The devaluation will diminish the global buying power of Chinese savers immediately, which hardly encourages consumption.  

Perspective

At one point in the day on August 5th, the DJIA was down 961 points, but it rebounded slightly to make up some of its losses, but the decline was still the market’s worst day of 2019.

Similarly, the S&P 500 recorded its worst day of 2019 and NASDAQ turned in its worst day since October 24, 2018.

But keep the following in perspective:

  • The DJIA is still up more than 10% YTD;
  • The S&P 500 is still up more than 13% YTD; and
  • NASDAQ is still up more than 16% YTD.

China’s latest move shows us why it should on every investor’s radar, but changing long-term plans in reaction to short-term market moves is probably not a good idea.

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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.