5 Implications of China’s Artificial Currency Devaluation

For the past few days, readers of any major Finance and Economics site have been unable to avoid the absolute drama related to the Yuan’s depreciation of almost 3% in two days.  This type of currency devaluation hasn’t been witnessed in over two decades.

Now to the principle domestic and global repercussions of China’s artificial currency devaluation.

1. Implications for GDP & Export volume: Relative to the previous five years, China has been struggling to maintain speed in export volume as well as overall GDP growth. This is partly due to the Yuan’s gaining strength in the global market. As a result of appreciation, countries generally experience a decrease in trade surpluses. In addition to the natural appreciation of currency, China is also experiencing a smaller trade surplus each year due to higher consumption rates and needs for foreign goods in its own domestic markets. In today’s economy, an 8% GPD growth is not sustainable. Past experiences have illustrated time and time again that economies must slow to around a 2-3% annual growth rate to maintain stability (while also holding a strong middle class for consumption needs).

2. Implications for Domestic and International Markets: Unlike many other currencies, the Yuan’s rate is an “official midpoint” which guides market trade with variability of an increase or decrease of 2% throughout the day. China’s central bank has made it clear that they do not anticipate a downward trend of the Yuan’s value but instead state that this is purely an adjustment. As mentioned in my previous article, there will be positive and negative repercussions via this decrease.

Positive impacts: Chinese exporters will certainly benefit from this currency decrease as global consumers will be required to pay relatively less for goods and services. Tourists wishing to visit China will also require a lighter wallet while traveling across the red kingdom due to decreased domestic prices relative to foreign currencies.

Negative Impacts: Domestic Chinese consumers will be less likely to purchase the relatively more expensive foreign goods. This will also hurt foreign exporters and retailers attempting to enter or remain in the Chinese consumer market. Chinese companies will also experience higher interest rates when paying off foreign debt in dollars or other currencies.

3. Implications for investment to service economy: At this point, China is reaching a threshold which all developing nations much bridge at one time or another. the country’s economy has been racing along with high GDP, export volume, and private investment. Unfortunately, the next step is one of the most difficult. This, of course, is transitioning over to a service economy. Currently structured as a strong manufacturing and investment outlet, China’s economy has been expanding rapidly over the past decade. Now China must transform into a more stable system, offering high-skilled labor and quality goods.The growth and export driven model has been exhausted and it’s now time for China to consider the long-run.

4: Implications for Yuan and SDR : The international Monetary Fund (IMF) dubs certain currencies to be so important to the stability of the global economy  that they are issued Special Drawing Rights (SDR). This implicitly means that member countries around the world must hold reserves of each currency in a “basket”. The weight of these currencies collectively value the (SDR) asset reserve. China wishes for the Yuan to be a part of the Special Drawing Rights as it will likely offer prestige and signal reliability in the marketplace. Still, the IMF has recently stated that the Yuan’s devaluation will not effect its chances of being selected.

5. Implications for consumption : China has indicated that the administration is more concerned about export and GDP growth than domestic consumption patterns. As shown by other developing nations such as the U.S. and Germany, a strong middle class is very important for economic stability. In attempts to catalyze the sputtering export economy, devaluing the Yuan has not only protected domestic producers but has also inherently decreased domestic working-class inclinations for spending. Due to higher prices for imported goods and lower purchasing power, the current economic policy is not doing any favors for domestic consumption.

To recap on what results China’s current economic policy moving forward may invoke, check out the WSJ here.

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No, appreciation IS NOT always helpful: A Lesson on Currency

Economics can sometimes appear merely as the subject we were all forced to take junior year of High-School. These days we occasionally hear about the markets progressing up and down; never quite refraining in constant volatility. Still, there are certain lessons which are essential to understand as both producers and consumers so that we do not over-generalize our current market economy. In this post I will review the principle effects of currency appreciation along with the massive impacts these pose on both individual participants and entire economies. Note that this article illustrates a broad scope on currency valuation and may not necessarily cover other smaller variables or views on economics policy.             

  • The domestic consumer: This category most likely encompass the average small-scale customer; you and I. We’re in luck!  Appreciation of domestic currency increases our purchasing power. Naturally this means that we can buy more domestic goods for the same exact dollar amount. Furthermore, foreign imports appear even cheaper due to the valuation disparity between currencies. So the news is out! Eat, drink, increase consumption, and be marry.
  • The domestic producer: In the same circumstance, appreciation in value of domestic currency, times are looking rough for the domestic producer. Since the domestic currency has appreciated against their own, foreign firms are less likely to buy goods from the domestic firm because this option now costs relatively more to the foreign company. On a large economic scale, a decrease in purchases from foreign firms and other consumers can take a devastating blow on the country’s overall import/export balance. Due to this negative trend, countries like China have sacrificed internal increases in consumption for a positive trade surplus by artificially undervaluing currency rates.                                                                       
  • Application in today’s economies: As seen by the countless recent WSJ posts (yesterday and today) regarding the devaluation of the yuan, China continues to push export surpluses by promoting artificial downward pressure on its currency. Unfortunately, this negatively impacts domestic consumption, reducing economic stability in the long run. Only recently has China begun allowing the yuan to fluctuate a bit more, allowing the currency to appreciate at generous amounts until they once again artificially reduce the value as China did yesterday. The US is on the other side of the spectrum at the moment, consistently experiencing trade deficits due to steady dollar appreciation. The US also releases periodic reports which give investors a fairly clear understanding of the strength of the dollar in the global market. As a result, many investors use the US dollar both as the generally accepted tool for international trade and the preferred currency for holding assets and cash accounts in “safe-havens”. This is all due to the dollar’s minimal value fluctuation. These characteristics can actually have a negative effect on the US economy due to high demand for the dollar in international money markets. In short, while domestic consumers enjoy strong purchasing power, domestic producers have a relatively more difficult time selling goods  and maintaining bottom lines as a result of currency appreciation.

7 Reasons China’s Economic Position is Tentative

Bubbles Upon Bubbles

Are we expected to believe that an annual GDP growth of 7%-8% is sustainable? Some investors are beginning to wonder if China will be going the way of Japan, losing two decades of economic expansion as a result of devastating fall-outs. If we are to expect great things from an up-and-coming world power, China needs to address its ever-growing property bubble. Some of these plays are torn directly from Greenspan’s own notes; stimulating markets in attempts to circumvent smaller crashes. Still, China’s tech bubble is surely another example illustrating the old idiom, what goes up must come down. As The United States’ inclination toward Keynesian ideology has shown, properly guided bubbles can work with proper understanding of natural repercussions. Unfortunately, China seems to be  setting itself up for some mammoth bubbles ahead.

Yuan, Renminbi (RMB) means
Yuan, Renminbi (RMB)

China appears to be intentionally pushing bubbles to maturity in hopes that the end result is greater than where the market began. With some hair of the dog, this strategy is none the less dangerous to all participants.

Artificially Inflated Currency

 Due to China’s high export volume, the country is holding a trade surplus. In these conditions your average nation would be experiencing appreciation of native currencies. This, in turn, would cause exports to become more expensive leading to noticeable decreases in export volume. Still, unlike other colossal economic world players, China intentionally keeps the Yuan’s strength in the dark. At first glance, the strategy could be considered admirable for a young growing  economy but the whole situation makes potential investors very uncomfortable. The Communist Party of China seems adamant to reduce volatility of the Yuan by keeping specific key measures out of public view. As a result, investors are less inclined to trust a currency which holds an uncertain definitive value.

Centralized Government 

While long gone from the visions of Chairman Mao, the People’s Republic of China’s economic and political structure is certainly still more centralized than other developed nations. With 22 provinces, 5 autonomic regions, 4 municipalities, and 2 special administrative regions, one may wonder how the argument is made that China’s political and economic systems are currently centrally operated. Not unlike Russia, the question is not so much how many government pieces are in play, but rather, who holds the king. Due to an overtly centralized government structure, decisions oftentimes exhibit conflict of interest; seeming to invariably favor Communist Party of China (CPC) members in capital centers. Along with an overly centralized government also comes a standard lack of follow-through in regulations and feed-back. Provinces are often found creating false metrics for the sake of embellishing reports to satisfy capital-based regulatory committees. Tendencies for Xi Jinping to strong arm smaller provinces toward unsafe labor practices in the name of economic glory are not unheard of. The key to economic and political stability in China is surely to appropriate power and proper representation toward smaller provinces, especially up-and-coming Wuhan, Chongqing, Xiamen, Ningbo, among several others.

Blatant Socio-Economic Disparities

Since the late 1970’s China has witnessed an unprecedented economic growth due to manufactured exports; experiencing up to 9% GDP growth for extended periods of time. In an attempt to increase consumption the government has begun pushing rural farmers off of ancestral lands toward the cities. History has repeatedly shown nations with a strong middle-class have a tendency to maintain consistent success due to high levels of domestic consumption. The urban-rural income gap can be attributed to policies favoring industrialization in large cities, while large-scale farming has only now begun receiving government subsidies toward staple crops. Current fiscal and monetary policies favor China’s steady migration toward exports of manufactured and assembled goods, further widening wealth disparities.

A China GDP

Private Loan driven Construction Projects 

Ghost cities containing luxury housing and countless amenities go uninhabited due to the severe lack of balanced wealth in the region. Investors speculate what will become of the ghost cities being built around China via leveraged funds. Will domestic private lenders refuse to offer the Chinese government further credit? Most likely not as private construction and real-estate agencies receive “economic incentives”  from the government in a pursuit to further stimulate economic growth through “infrastructure development”. Unless China addresses its wealth disparity and moves forward to build a larger middle class, consumption will remain low and the cities will remain uninhabited.

Patent Law Rarely Enforced

The accepted principle of the game is truly based on saving face. Due to the borderline non-existent enforcement of patent law (especially with international corporations) potential investors are hesitant to set up Green Field projects, much less joint-ventures. In an attempt to increase domestic investment, China allows investors to introduce new international non-native brands to the Chinese demographic if the company agrees to partner with a Chinese firm for the project. Oftentimes, these scenarios result in the theft of patented procedures and goods. Because of a seemingly non-existent patent law enforcement procedure, foreign companies find themselves market shaming Chinese companies into not using stolen information.

Conversion From “Blue Collar” to “Service” Economy 

While India’s infrastructure isn’t yet admirable, the populous has made impressive strides toward becoming a well paced service economy, functioning on skilled-labor. Xi Jinping (China’s president) seems very fond of manufacturing tangibles in bulk through low-skilled labor at very low cost (for exporting). With a looming elderly population growing into their “golden years” China’s current welfare systems may not prove adequate. After installing the one child policy, the country successfully reduced birth-rates, slowing population growth to a reasonable level. Now for a bit of foresight on the matter. Unless China works out a way to convert from manufacturing labor to high-paying/ higher skilled, service and tech concentrations, younger populations may struggle to contribute adequate capital toward the sustenance of enormous elderly populations. The math is fairly simple. Either the aging population must continue working to support itself, or the weight will soon be borne by the considerably fewer “millennials”.