Currency wars are driving down the Sensex

Vivek Kaul

The BSE Sensex fell by around 1624.51 points or 5.94% to close at 25,741.56 points yesterday (August 24, 2015). Sensex is an index of 30 major stocks that are traded on the Bombay Stock Exchange.

By now, dear reader, you may have read at many places that this was the biggest fall of the Sensex ever. That is incorrect. It was the 29th biggest fall of the Sensex, if we look at falls in percentage terms, which is the right way of looking at the situation.

Further, it was the biggest fall of the Sensex in more than six and a half years. On January 7, 2009, the Sensex had fallen by 7.25%. That was the day when B Ramalinga Raju of Satyam Computers confessed to a fraud. All falls after January 7, 2009, have been lower than yesterday’s fall.

So the question is why did the Sensex fall as much as it did yesterday?

The simple answer is—currency wars. In October 2012, the 80 Japanese yen were worth a dollar. As I write this on August 24, 2015, around 118 Japanese yen make for a dollar. The Bank of Japan (their equivalent of Reserve Bank of India) has been printing yen in the hope of driving down the value of the yen.

Why has it been doing this?

This is being done to make Japanese exports more competitive. A fall in the value of a currency means exporters can make more money. It also allows them to cut prices and hopefully boost exports and in turn economic growth. At the same time, the idea is to make Japanese imports more expensive.
China competes with Japan when it comes to exports. In July 2015, Chinese exports were down by 8.3%. During the same period Chinese exports to Japan were down by more than 10%.

Between August 11 and August 14, the People’s Bank of China, the Chinese central bank devalued its currency, the yuan, against the dollar. Before August 11, 6.2 yuan were worth a dollar. Now around 6.4 yuan are worth a dollar. This was done in the hope of boosting Chinese exports and in turn Chinese economic growth. The fear is that China will devalue the yuan further.

But why is that driving down the stock market?

If China devalues the yuan further, Chinese exports will become cheaper. This will mean that prices of goods produced in countries like United States and in large parts of Europe will have to be cut, in order to remain competitive with Chinese imports. This will lead to a scenario of what economists call “deflation” or falling prices in these countries. The Western economies will contract or not grow at the same speed. The stock markets around the world are adjusting to this “expected” situation. The Indian market is not an exception to this, as most of the money invested in the Indian stock market belongs to foreign investors.

What should you do?

A lot of experts have said that this is a good time to buy. That may actually not be the case. As I write this, the Dow Jones Industrial Average, one of the premier stock market indices in the United States, is down by more than around 500 points or 3%. Chances are the Sensex’s fall may continue as well. This is a risk not worth taking.

Also, it is worth remembering the old adage of drinking stocks SIP by SIP, where SIP stands for a systematic investment plan. Since the start of January 2008, Sensex has given a return of 5% per year. But an SIP on a good mutual fund would have given you a return of higher than 15% per year. This is timeless advice and works at most points of time.

The column originally appeared in the Bangalore Mirror on August 25, 2015

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)