There is much to talk about after the Chinese sent a shot across the bow of the U.S.S. Financial Complacency. If we glance at the currency charts of various global currencies versus the Chinese YUAN it is easy to see what the authorities setting policy in Beijing are so very concerned about. The YUAN may be very stable against the U.S. dollar but in terms of Brazilian real, Turkish lira, Mexican peso, Aussie dollar, euro, British pound, Japanese yen and Korean won, the YUAN has undergone a MASSIVE appreciation during the last three years. While the Chinese were announcing their intentions to attempt a pivot to a more domestic-consumption economy, a strong YUAN favored a structural change of such magnitude.
Professor Michael Pettis has long argued that an increase in domestic consumption in an economy with large trade and current account surpluses needs a strong currency as currency strength makes imports cheaper, which enhances the wealth of the middle class consumers. DOES LAST NIGHT’S MOVE SIGNAL THAT THE CHINESE POLICY MAKERS HAVE BECOME CONCERNED THAT DOMESTIC CONSUMPTION WILL BE UNABLE TO ABSORB THE CAPACITY CREATED BY PREVIOUS MASSIVE CAPITAL INVESTMENT? This is the critical question for the global economy for if the Chinese are threatening to ramp up its exports to prevent a domestic slowdown then DEFLATION will have a new source of energy as Chinese exports seek to compete in all markets. Yes, last night’s move in the YUAN was a mere 2%, but it is a warning to world economy that the Chinese will not play the fool at the global financial “poker table.” If the deck is fixed the Chinese are demanding a reshuffle with new cards.
One day doth not a trend make but it is important to pay close attention to sustained fallout from the Chinese action. What will the response be from other members of the global financial community and will Madame Lagarde be in favor of the Chinese action? The IMF has warned the FED not to prematurely raise rates as it could upset the fragile state of the emerging economies. If the FED retreats from the “hawkish” statements of Atlanta Fed President Dennis Lockhart, then IMF Director Lagarde will probably see the Chinese action in a positive light.
In a speech that Lockhart delivered yesterday, the mouth of the South said: “As the Committee approaches what I consider a historic decision, I am not expecting the data signals to point uniformly in the same direction. I don’t need this. I’m prepared to see mixed data. Data are inherently noisy month to month and quarter to quarter. Given the progress made over the recovery and the overall recent tone of the economy, I for one do not intend to let the gyrating needle on monthly data be the decisive factor in decision-making.”
Maybe Lockhart can ignore month-to-month swings in the Atlanta GDP NOW survey but can he ignore the deflationary impact from the Chinese depreciating its currency against a basket of global currencies? Remember, the target by Beijing is not the U.S. dollar but all the currencies who have depreciated their currency values versus the Chinese YUAN. Those massive downward moves have been over a fairly short time frame. The YEN has depreciated almost 40% versus the Chinese currency during the last three years. There will be much more to this story as the Chinese make statements in response to global criticism. A few things to note in market response to the Chinese announcement:
These are just some conjectures. As always, let the markets be your guide and wait for events to unfold further before making a major financial commitment. The object it to limit losses while seeking the greatest return on risk capital.