Yuan thing af­ter another for China econ­omy


We are in one big global mess. On Aug. 11, an un­ex­pected 1.9 per­cent de­val­u­a­tion of the yuan fu­eled fears about the out­look of the Chi­nese econ­omy, set­ting off falls in com­mod­ity prices and emerg­ing mar­ket (EM) cur­ren­cies and eq­ui­ties over an ex­tended pe­riod.

Stock mar­kets in Europe and the United States wob­bled and then fell sharply, cul­mi­nat­ing in the 1,000 points in­tra-day drop in the Dow Jones In­dus­trial In­dex on Black Mon­day (Aug. 24).

Cop­per, alu­minium, zinc and lead prices hit five to six-year lows; oil fu­tures fell be­low US$40 a bar­rel; and the ring­git dropped to its low­est level since the Asian cri­sis in 1998.

As I see it, no sin­gle fac­tor can be held re­spon­si­ble, even though most mar­ket man­agers say China’s poor eco­nomic out­look pro­vided the spark. But what’s driv­ing the two ma­jor na­tions — and their com­plex re­la­tion­ship — form the ba­sis to­wards a bet­ter un­der­stand­ing of what’s go­ing on.

The United States, still the world’s largest econ­omy, re­mains the global fi­nan­cial pow­er­house that sets the global di­rec­tion in in­ter­est rates and cur­ren­cies. China — still the world’s fastest grow­ing big econ­omy, is in the midst of a dif­fi­cult tran­si­tion in­volv­ing mar­ket re­forms that’s not work­ing ac­cord­ing to the­ory.

The two largest global economies ap­pear to be pulling in dif­fer­ent di­rec­tions. While growth in the U.S. econ­omy has been blow­ing hot and cold, it is be­gin­ning to gather pace with un­em­ploy­ment now inch­ing down to 5 per­cent.

At this time, China’s econ­omy is be­gin­ning to show more signs of weak­ness and los­ing steam. Still, it is de­ter­mined to main­tain gross do­mes­tic prod­uct (GDP) growth in the re­gion of 7 per­cent and has enough de­grees of free­dom in pol­icy eas­ing to reach this goal. But the task is daunt­ing.

Get­ting Squeezed

Nev­er­the­less, this di­ver­gence be­tween the two giants is caus­ing un­cer­tainty and much anx­i­ety, even trou­ble — es­pe­cially among the EMs which had ben­e­fited from ex­pand­ing Chi­nese de­mand ( em­a­nat­ing from its in­vest­ment boom) and from the flood of cheap credit and easy money from the United States in par­tic­u­lar.

U. S. growth prospects re­main pos­i­tive. But it also means that the “lift-off” in in­ter­est rates is em­i­nent — the first time in al­most a decade. That means U.S. dol­lar can strengthen — al­ready up more than 15 per­cent against its trad­ing part­ners over the past two years.

This puts a squeeze on EMs: (i) from cap­i­tal out­flows to cap­ture higher yield­ing U.S. as­sets; and (ii) from ris­ing cur­rency risks in ser­vic­ing EM’s US$1.3 tril­lion of U.S. dol­lar debt raised since 2010. The largest bor­row­ers be­ing China, Brazil, Mexico and South Korea. But China is slow­ing down. Its great­est im­pact is on com­mod­ity pro­duc­ers, from In­done­sia to South Africa. Also on Sin­ga­pore to South Korea and Tai­wan.

Even In­dia is feel­ing the pain — es­pe­cially from the dump­ing of cheap Chi­nese steel. Also, the United States and China go­ing their sep­a­rate ways have fur­ther com­pli­cated their al­ready com­plex re­la­tion­ship. U.S. “pres­ence” in the ter­ri­to­rial dis­pute among China, Ja­pan and ASEAN is un­wel­come.

Un­til re­cently, the yuan had tracked U.S. dol­lar’s as­cent de­spite China’s slow­ing econ­omy — in­deed, the yuan had ap­pre­ci­ated by more than 10 per­cent against its trade weighted bas­ket since 2014. Its re­cent re­ver­sal has prompted con­cerns that with its growth sput­ter­ing, prospects of a cur­rency war looms large.

I think such fears are overblown. I see the re­cent move more as be­ing de­signed to strengthen the mar­ket role in de­ter­min­ing the yuan’s value. Sub­se­quent events have kept the yuan value in line with those of its peers — and re­mains part of its re­form ex­er­cise, not a shift in ex­change rate pol­icy.

Mar­ket Cor­rec­tion

Global stocks and com­mod­ity prices fell sharply early on Aug. 24 as the pre­vi­ous week­end’s melt­down in­ten­si­fied.

The Dow was in cor­rec­tion-mode on the pre­vi­ous Fri­day, fall­ing 10 per­cent from its pre­vi­ous peak fol­low­ing its worst week since 2011 when U.S. sov­er­eign debt rat­ing was down­graded.

In stock­mar­ket-speak, a “cor­rec­tion” refers to a 10-per­cent de­cline in the price of a widely fol­lowed in­dex (such as the Dow or S&P500).

It slips to be­come a “bear” if the fall is 20 per­cent or more (just a rule of thumb). Black Mon­day’s Dow plunge was the big­gest ever in­tra­day point de­cline, fol­low­ing the 8.5 per­cent fall in the Shang­hai Com­pos­ite which pushed it into neg­a­tive ter­ri­tory for 2015, hav­ing risen by as much as 60 per­cent to its June peak (af­ter dou­bling over the pre­ced­ing 12 months).

The pan-Euro­pean Stoxx Europe 600 closed 5.3 per­cent lower, the big­gest one-day fall since De­cem­ber 2008, los­ing all its gains in 2015. Stock mar­kets across Asia — from Ja­pan to Aus­tralia — slid more than 4 per­cent on Black Mon­day.

A large num­ber of cur­ren­cies in the re­gion fell to multi-year lows. Ja­pan’s Nikkei bench­mark tum­bled 4.6 per­cent, and Ger­many’s DAX, 4.7 per­cent — hav­ing now lost more than 20 per­cent since its April peak. Oil prices fell 4 per­cent while ba­sic re­sources firms on the Stoxx 600 were down 9.3 per­cent.

The speed of the re­cent sell-off has left in­vestors ner­vous and un­cer­tain. The no­to­ri­ous “fear gauge, VIXX” (the CBOE Volatil­ity In­dex) had more than dou­bled over the past week, the big­gest weekly rise on record.

All these re­flect in­tense weak­ness in com­modi­ties and EMs as well as con­cerns about China and over­all global growth, and ris­ing risk of yet another fi­nan­cial cri­sis. But some­times, mar­kets do get quirky; ir­ra­tional be­hav­ior takes over and de­vel­ops a logic of its own.

That’s in the na­ture of mar­kets — they of­ten tend to over­shoot and un­der­shoot. In the last six trad­ing days un­til Aug. 25, the Dow had lost nearly 1,100 points, or 11 per­cent.

Mar­kets Get Bat­tered

As a re­sult of be­ing squeezed, pol­i­cy­mak­ers in many EM na­tions are strug­gling to cope with sev­eral fac­tors be­yond their con­trol that have, when com­bined and in con­junc­tion with desta­bi­liz­ing “host” so­cialpo­lit­i­cal is­sues, hit their cur­ren­cies hard.

Among them are grow­ing doubts about the health of the Chi­nese econ­omy, the sharp de­cline in oil, ba­sic food and in­dus­trial met­als prices, the like­li­hood of ris­ing U.S. in­ter­est rates and in the case of Malaysia, ir­re­duc­ible un­cer­tainty and con­stant anx­i­ety over po­lit­i­cal sta­bil­ity is­sues.

As a re­sult, global money man­agers have pulled-out an es­ti­mated US$26 bil­lion in EM stocks and bonds dur­ing the first seven months of this year. There has been prac­ti­cally a to­tal car­nage of com­mod­i­ty­based cur­ren­cies.

The mood is grim from the South Africa rand to Kaza­khstan’s tenge; from Viet­nam’s dong to the ru­piah to the ring­git. The tenge has since fallen by more than 25 per­cent against U.S. dol­lar; the Brazil­ian real by 35 per­cent (cur­rently at a 12-year low) and South African rand by 13 per­cent, while Viet­nam’s dong for­mally de­val­ued again for the third time. By now, the ru­piah is down by 12.5 per­cent and the ring­git, by 18 per­cent to a 17-year low and by 29 per­cent over the past 20 months.

Malaysia’s eco­nomic- so­cialpo­lit­i­cal un­der­pin­nings have eroded sig­nif­i­cantly since end-2013 and in­vestor con­fi­dence has been badly shaken. Given poor sen­ti­ment, cap­i­tal out­flows (both short and long) have been sig­nif­i­cant. Still for­eign­ers con­tinue to hold about 45 per­cent of the gov­ern­ment’s debt, while pri­vate for­eign cur­rency de­nom­i­nated bor­row­ing (mainly in U.S. dol­lar) to­day ac­counts for about 24 per­cent of GDP.

Malaysia ur­gently needs to fix (and re­form) its in­vest­ment ecosys­tem. Above all, it badly needs de­pend­able states­man-like po­lit­i­cal lead­er­ship to re­vive con­fi­dence. At the end of the day, the com­bi­na­tion of a weak­en­ing cur­rency and the ab­sence of firm, pre­dictable po­lit­i­cal sta­bil­ity is af­fect­ing ev­ery­body, in­clud­ing meet­ing the ul­ti­mate aim of public pol­icy to raise liv­ing stan­dards.

For most EM cur­ren­cies, they need to ad­just to the re­bal­anc­ing tak­ing place in the global econ­omy, in par­tic­u­lar to the of­ten di­ver­gent pol­icy stance of the United States, Europe and China. The ru­piah, ring­git, baht, dong, lire, rand and real con­tinue to re­main vul­ner­a­ble.

What Then, Are We to Do?

Un­like pre­vi­ously, China is to­day in­tri­cately con­nected to the world com­mu­nity. Its global foot­print is fast ex­pand­ing. It is no co­in­ci­dence that the re­cent mar­ket crash is cor­re­lated with both tepid un­der­ly­ing world growth and with the vast cap­i­tal out­flows from EMs. These three trends are mu­tu­ally re­in­forc­ing. So the world has changed. Still, higher U.S. in­ter­est rates (when it comes) need not spell doom. If the “lift” is grad­ual (as ex­pected), EMs may not feel it all that much.

The pre­sump­tion that the U.S. dol­lar will fur­ther strengthen as a re­sult has not been proven em­pir­i­cally. In the first 100 days of the four big U.S. tight­en­ing cy­cles over the past 30 years, U.S. dol­lar ac­tu­ally weak­ened ev­ery time. So, higher rates will add to the al­lure of U.S. dol­lar as­sets but may not ac­tu­ally drain-off too much more cap­i­tal from EMs. But there are just too many mov­ing parts. Un­til the mar­ket cor­rec­tion set­tles down, EM cur­ren­cies sta­bi­lize, and the real econ­omy shows clear signs of health, the stench of cri­sis will re­main.

What’s the in­vestor to do? I sug­gest four things:

— Stay cool: U.S. stocks are not re­ally cheap even af­ter Black Mon­day, trad­ing at 24.9 times av­er­age long-term earn­ings ac­cord­ing to No­bel Lau­re­ate Yale pro­fes­sor Shiller (down from 27 times in early 2015).

— Ig­nore blow- by- blow news: Con­stant up­dat­ing about the mar­kets only un­set­tles and blurs your per­spec­tive. Fo­cus on your long-term goal.

— Ig­nore ut­ter­ances of “cor­rec­tion” or “bears” and “bulls”: They have no real sig­nif­i­cance. What mat­ters is the fu­ture out­look.

— What’s go­ing to hap­pen?: Mar­ket pun­dit talk is just that — talk. No one re­ally knows what the mar­ket will do next. Trust your gut-feel and self-knowl­edge against ir­re­duc­ible un­cer­tainty.

If you have not suf­fered any loss, you shouldn’t be in stocks — and shouldn’t feel de­prived ei­ther! Good luck.

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