The Chinese are letting their currency devaluate in an attempt to revive a slowing economy. We wonder if this is the death of the Chinese economic miracle. The Wall Street Journal reports that U.S. stocks are sharply lower after the Chinese currency move.
U.S. stock indexes slid Tuesday after China’s devaluation of its currency signaled growing worry about slow growth from one of the world’s biggest importers of raw materials.
The onshore yuan on Tuesday posted its biggest one-day loss in two decades. A weaker yuan could hurt the competitiveness of firms outside China by making their goods and services relatively more expensive, while companies that generate sales in China could find revenue generated in yuan is worth less in their home currency.
The bosses of the managed capitalism economy have often seemed infallible as cheap labor attracted foreign investment and produced cheap and profitable exports for decades. However, we have often compared China to Japan of the 1980’s when the Japanese seemed ready to take over the world. A glut of hidden debt took down the Japanese economy and sent it into two decades of deflation. If this is the death of the Chinese economic miracle hidden debt may be the culprit for China as it was for Japan.
Many people know that China holds a few trillion in hard currency reserves. However, many businesses in China have debts denominated in U.S. dollars and not yuan. The Financial Times reports that China’s dollar debts come under pressure as the yuan devaluated.
China’s surprise devaluation of the renminbi has stunned markets and stands to escalate a regional currency war. Further, while a weaker currency is seen helping bolster China’s sagging economy, any macro benefits must be weighed against costs. These mainly fall on those domestic companies and banks that have dollar-denominated debt and face the prospect of paying them back via a weakening renminbi.
Among the broader market implications looms further downward pressure on commodity prices and on blue-chip equities in the developed world, as multinational companies face the prospect of slowing demand from China and a firmer US dollar.
A big and more immediate risk, however, is that investors and other emerging market countries will expect further weakness in China’s currency.
It also remains to be seen whether the higher debt servicing costs for Chinese companies and banks that have borrowed dollars sparks a massive unwind of such loans, pushing the dollar sharply higher.
If this downward slide of the yuan accelerates it could we spell the death of the Chinese economic miracle.
What Is the End Result?
When a country is in trouble and takes steps to devalue its currency it can become a self-fulfilling prophecy as the market expect repeated devaluations and drives the currency down. The world is seeing a Forex world of competitive devaluations. The end result of the yuan devaluations could be an accelerated Forex race to the bottom which China will not necessarily win. The problem for China is that it needs to build up local consumption and not rely on exports for continual growth. MarketWatch says that this move ramps up the risks for investors and the Chinese economy.
The fault line in China’s struggling economy has just extended from its equity to its currency markets. With all eyes focused on Beijing’s epic, state-orchestrated stock-support program, the central bank on Tuesday surprised markets with an almost 2% devaluation of the yuan, the largest since 1994.
Investors now need to assess whether China is ready to embark on a new yuan weakening cycle. While this may boost exports and give the economy a lift, it is also a potentially hazardous path as authorities juggle potential capital flight and corporates holding substantial foreign currency debt.
The flight of capital out of China may accelerate and seal the death of the Chinese economic miracle.