Ideally, I should have written this column last week, but this trend isn’t going anywhere anytime soon. On August 11, 2015, the People’s Bank of China, the Chinese central bank, engineered a 1.9% cut in the value of the Chinese yuan against the US dollar. This was the largest single day cut in the value of the yuan against the dollar in two decades. The Chinese yuan doesn’t move freely against the dollar. The People’s Bank of China controls its value. Before last week’s cut, 6.2 yuan equalled a dollar.
As I write this on August 17, 2015, around a week later, 6.4 yuan are worth a single dollar. The value of a currency is a big variable for exporters. But by ensuring the yuan had a fixed value against the dollar, the Chinese central bank took this variable out of the Chinese exporters’ equation totally. This helped Chinese exports and exporters flourish and has been a very important part of the Chinese economic miracle.
Nevertheless, Chinese exports have been falling lately. In July 2015, Chinese exports fell by 8.3% compared to a year earlier. Even in June 2015, the exports had gone up by only 2.8%. A major reason for this is that the Bank of Japan, the Japanese central bank, has rapidly driven down the value of the Japanese yen against the dollar. In October 2012, 80 yen made up a dollar. As I write this, around 124.5 yen make up for a dollar. This has made many Japanese exports more competitive than China’s. Further, it has made imports into Japan more expensive. This caused Chinese exports to Japan between January and July 2015 to fall by 10.5%.
So it’s not surprising that the Chinese authorities pushed down the value of the yuan against the dollar. Their goal is to boost Chinese exports while making imports into China more expensive, thereby pushing the sales of local Chinese made goods and boosting economic growth in the process.
The People’s Bank of China decreased its foreign exchange reserves by $300 billion over the last four quarters. In other words, in a bid to keep the yuan at 6.2 for every dollar, the Bank has been selling dollars from its kitty and buying up yuan, which is essentially money being taken out of the country.
The People’s Bank doesn’t have an unlimited supply of dollars. At some point, it had to let the value of the yuan fall against the dollar, which is precisely what it did last week. For years on end, China has grown at double-digit rates. But recently, as global demand has fallen in the aftermath of the financial crisis which started in 2008, economic growth has slowed to 7% per year. In fact, many China followers believe the official 7% figure is an overstatement.
For example, Ruchir Sharma, Head of Emerging Markets and Global Macro at Morgan Stanley, wrote in a recent column in The Wall Street Journal that: “While China reported that its GDP grew exactly in line with its growth target of 7% in the first and second quarters this year, all other independent data, from electricity production to car sales, indicate the economy is growing closer to 5%.”
Most China experts and analysts fail to mention this, but it is important to understand that economic growth gives legitimacy to the unelected communist government that runs China.
As John Plender writes in Capitalism: Money, Morals and Markets: “Unelected Chinese politicians may put the interests of the Communist Party elite before those of the nations. Their legitimacy, after all, rests chiefly on the continuation of high rates of economic growth. If they fail to deliver, their survival in an economic crisis may depend on whipping up nationalist popular feeling against Japan, Taiwan or other Asian neighbours, intensive trade relations notwithstanding.”
This phenomenon was at play in the recent past, when the Chinese government tried to do everything to stop the stock market from falling. It banned investors with more than a 5% holding in a company from selling shares and it directed big financial institutions to invest in the stock market. These moves were to prop up stocks, but mostly to maintain political legitimacy.
Since the financial crisis, the Chinese politicians have been able to maintain credibility by ensuring that the economic growth has not collapsed, as it has in much of the Western Word. This has been done by lending cheap money across various sectors. As Sharma of Morgan Stanley writes: “The problem is that China’s economic rise of late has been facilitated by a massive and unsustainable stimulus campaign. No emerging nation in recorded history has ever tacked on debt at such a furious pace as China has since 2008, and a rapid increase in debt is the single most reliable predictor of economic slowdowns and financial crisis. China’s debt as a share of its economy increased by 80 percentage points between 2008 and 2013 and currently stands at around 300%, with no sign of abating.”
This easy money first led to a property bubble, which was followed by an infrastructure bubble and a stock market bubble.
The point is that the Chinese politicians will do whatever it takes to keep the economic growth going. So expect the devaluation of the Chinese yuan against the dollar to continue, as China tries to push up its exports again.
As Albert Edwards of Societe Generale writes in a recent research note: “For although the PBoC [People’s Bank of China, the Chinese central bank] said the move was a one-time adjustment [the drop in the value of the yuan against the dollar] to reflect changes in the way it calculates the daily fix, it also said that the price would be set “in conjunction with demand and supply conditions in the foreign exchange market and exchange rate movements of the major currencies.”
What does this mean? Well, the race to the bottom isn’t exactly rocket science. With the yuan’s value now down against the dollar, chances are that the Bank of Japan will respond by printing even more yen, in a bid to further drive down the value of the yen against the dollar. The South Korean central bank may also do something along similar lines in order to drive down the value of the won [the South Korean currency] against the dollar to protect its exports. This in turn will lead to the People’s Bank of China to push the yuan down even further against the dollar. Rest assured, the currency wars in Asia will continue.
The column originally appeared in The Daily Reckoning on Aug 18, 2015