A little yuan devaluation created a strong reaction in markets around the globe. A less than 2% devaluation in CNY is not probably going to make Chinese companies overnight super-competitive in exports - they already are reportedly, and CNY is still way below recovering its appreciation against USD for last two years. Nor the foreign investors will worry about a 2% hit in their portfolio. The swings in Chinese equities demand their undivided attention. And no way this is going to spiral in to a currency crisis in a typical EM style with large external debt. This has a mere ~USD 20 Billion impact on Chinese external debt, even if you assume the entire pot is dollar denominated. That pales in comparison to recent capital outflows from China.
The surprise move is rather across global equities - which according to Bloomberg are selling off because of these Chinese incident.
Seriously? Germany has a large CA surplus against China, so yes, DAX should get a hit, UK has a large deficit, so FTSE should go up? Oh wait, what about less Chinese tourists, of course. Rhymes and reasons.
This is China trying to get more market in FX fixings, perhaps with an eye for SDR node from IMF. This has nothing to do with export competitiveness, or currency wars or anything.
What will be more worrying, indeed, if this has got anything to do with recent large capital outflows. If there is a large capital inflow in a country, the local currency should shoot up against dollars. To maintain a peg, the central bank must buy the foreign currencies (and invest in treasuries) and thus inundate the economy with liquidity in local currency. Quintessential Chinese story until very recently. The thing is: this machine runs in reverse for capital outflows. Now in this context, if today's devaluation, recent capital outflows and selling of treasuries by China (presumably the central bank and the sovereign wealth fund) are all related, then there is a little to worry there. In China you never know. But I would still not lose sleep over it.
With CNY depreciating, all countries having trade relations with China face the prospect of falling trade surplus/rising trade deficit. So both DAX and FTSE should fall some, right? So what is the surprise?
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ReplyDeleteStock markets are not directly related to a country's trade surplus or deficits. It is driven by the profit and loss impacts of the resident companies in that country. If Germany has a surplus, you can assume German companies gain revenues by selling to the Chinese, and let's assume the cost is unrelated to CNY. A CNY depreciation will reduce revenues with same cost base. Net impact is lower profit and that feeds in to the stock market negatively. For UK it is the reverse. Companies purchase from China, and again let's assume the revenue is unrelated. So CNY depreciation makes input costs cheaper, and margins better. So markets should go up? No?
Well, you have made a huge assumption of revenue being constant and there are two more implied assumptions here: Import from China is mostly goods and that UK end products face no competition from Chinese ones. Now while the second assumption is correct, the first and third are definitely not. The major markets for UK end products are EU and UK itself and Chinese products become more competitive in both these markets now. Hence, real possibly of revenue falling, whether due to lesser sales or reduction in selling prices.
ReplyDeleteWell, you have made a huge assumption of revenue being constant and there are two more implied assumptions here: Import from China is mostly goods and that UK end products face no competition from Chinese ones. Now while the second assumption is correct, the first and third are definitely not. The major markets for UK end products are EU and UK itself and Chinese products become more competitive in both these markets now. Hence, real possibly of revenue falling, whether due to lesser sales or reduction in selling prices.
ReplyDeleteyou are right, this is dumbed down with too many assumptions there. the impact of currency misalignment in international trade is murky and non-linear, theoretically and empirically. The point is do you think it is start of a trend and towards undervaluation. Forget about UK and Germany; they are only examples. Suppose the world has three countries, A, B and China. A only exports to china, B only imports from China. If there is a devaluation leading to adjustment to fair value, then most trade theory agrees world as a whole will see improved growth (Pareto efficient). How the growth is shared is complicated. But that also means it does not make sense for a world wide risk-off move. Unless you think the Yuan move is growth-negative. Which perhaps means Yuan is moving towards unfair devaluation in sustained manner. Or it will create deflationary pressure (I do not think it will), or there is a chance PBOC is misunderstood, and this creates uncertainties in Yuan for a sustained period. Something in that line.
ReplyDeleteSo my basic assumption is I trust PBOC and think this is one-off controlled move. And I think the move is towards fair valuation than under valuation. And this will start no currency war (look and TWI CNY). So I am reasonably certain the risk assets will shrug it off pretty soon.
of course this depends upon the intention and credibility of PBOC. The last paragraph in the main text indicates what can go wrong. A little loosening the band here and changing fixing there may not stop the expectation of continued devaluation. That is not necessarily bad. It will be bad if it is unmanaged.
ReplyDeleteGood point in the last para. I think China is already dumping treasury securities (apparently through some Belgium entity: Source Zerohedge), but quantum would matter a lot.
ReplyDeleteSure, that's an important issue. The numbers are available on the US Treasury TIC website (http://www.treasury.gov/resource-center/data-chart-center/tic/Pages/index.aspx). Check the official flows country wise. And yes many sovereign wealth funds operates out of Belgium/ Luxembourg (like many hedge funds operate out of Caribbean Islands).
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