George Magnus Fears "Looming Threat Of A Yuan Depreciation"

Authored by George Magnus via Nikkei Asian Review,

Sino-American trade war could trigger a currency shock in Asian markets..."

When the Asian financial crisis occurred 20 years ago, many nations in East and Southeast Asia succumbed because they were following inconsistent domestic and international economic and financial policies. But one trigger was the 50% fall in the Japanese yen against the dollar between the end of 1995 and the summer of 1998 amid the American stock market's bull run that lasted until 2002.

Fast forward to today, and the dollar is on a roll again, thanks to a strong economy and tensions between its fiscal and monetary policies. Higher U.S. interest rates and a stronger dollar are already raising debt interest costs for Asian borrowers, but this time the falling Chinese yuan looms as a proximate cause of trouble.

Asia's vulnerability to developments in U.S. financial markets has been widely noted. It is true that unlike the Asian financial crisis of 1997-1998, most countries in the region have stronger foreign exchange reserves. They are better positioned when measured against important indicators such as months of import cover, short-term debt and foreign debt ratios.

Most Asian countries have current account surpluses, and even those with deficits, such as India, Indonesia, Myanmar and the Philippines do not look overly challenged. But while the sensitivity to shocks is lower than it was 20 years ago, there is no cause for complacency. And there is still a potential spoiler, the yuan, which is now under downward pressure, but which was an agent of calm in the last Asian crisis.

The yuan has weakened by more than 8% against the dollar to 6.83 yuan from a high of 6.28 yuan in March. This is far off the low of 6.96 yuan at the end of 2016 before China tightened capital controls significantly. To some extent, this reflects the markets' reaction to the evolving U.S.-China trade war, as well as some guidance by the People's Bank of China.

But it also has to be seen in the context of the cumulative consequences of tighter Chinese financial policies over the last 18 months, which has resulted in the loss of economic momentum. In response, there has been a recent loosening of monetary and financial policies, in which bank reserve requirements have been trimmed three times this year, short-term interest rates have eased, and longer-term rates have dropped more markedly.

In this context, a Sino-American trade war is not only most unwelcome but also untimely. In July, the U.S. implemented a new 25% tariff on $50 billion of imports from China. U.S. President Donald Trump threatened to increase the tariff rate from 10% to 25% on a further $200 billion of imports from China if the latter retaliated (which it did), and even subject all $500 billion or so of annual imports to tariffs. Beijing's riposte was to threaten variable tariffs on an additional $60 billion of imports from the U.S.

Since China only imports about $150 billion of goods from the U.S., the scope for its own tit-for-tat tariffs is almost exhausted. If it wants to continue hitting back at the U.S., it will have to resort to some combination of currency depreciation and the use of its extensive system of regulations to target U.S. products and companies doing business in China. As far as depreciating the yuan is concerned, the Chinese authorities are moving into dangerous territory.

So far, the 8% weakening in the currency against the US dollar has more or less compensated for the U.S. tariffs imposed. But because China's tit-for-tat tariff capacity is limited, any further broadening of U.S. tariffs, as Trump has proposed, would require the currency to decline further in value to around 7.25-7.30 yuan against the dollar or even more.

This would take the currency back to levels not seen since the major currency reform and alignment of multiple exchange rates in 2008.

From a technical perspective, chart investors worry that the fall of the yuan to below 7 to the dollar could open the way for a marked depreciation. This might happen in any case in due course, because of a weaker domestic economy and associated policy easing. But now would not be good time.

Washington would see any further significant fall in the yuan as a serious escalation of the trade war, and the chances of halting or lessening it would be gone. It would probably unhinge other Asian currencies as well as global markets.

Since the Asian financial crisis, supply chains have grown bigger and more intricate and trade dependencies have become greater. This means that global sensitivity to significant change in the yuan -- increasingly the anchor currency in Asia -- is more significant. Whether they are dependent on transnational supply chains, exports to China or income from Chinese tourists, Asian nations in both Southeast and Northeast Asia are likely to be concerned about a major fall in the yuan.

For China to sanction a sharp depreciation might be "a bridge too far" for all these reasons. It would certainly represent a major risk to domestic financial stability in China when there are reports emanating from Beijing that not everyone is happy with President Xi Jinping's handling of the trade dispute with the U.S. or, more generally, with his authoritarian leadership and its consequences for the country.

A yuan depreciation could also trigger a resumption of capital flight, even though the post-2016 system of controls has proved to be much less porous than the previous regime. The People's Bank of China is now acting to penalize traders who are looking to go short on the yuan. It has the tools, including the use of currency reserves to intervene, to stand its ground if the politics so dictate.

Asia should play close attention to China's central bank in coming weeks, and equally, to the bigger picture in which further yuan depreciation may happen, regardless of how China chooses to manage it. All of this means that policymakers -- regional and otherwise -- should be prepared to allow a mixture of responses, from local currency depreciation to monetary and fiscal measures, to address the consequences.

*  *  *

George Magnus is an associate at Oxford University's China Centre and former chief economist at UBS. His latest book is "Red Flags -- Why Xi's China is in Jeopardy," to be published in September by Yale University Press.

Comments

ZoroAustrian pc_babe Thu, 08/09/2018 - 21:25 Permalink

Kudlow and Trump crow about strong US markets and China being a lousy investment, as if markets are accurately reflecting fundamentals, yet declining RMB is currency manipulation.  Totally intellectually inconsistent.

Western commentators fall over themselves talking about how dissatisfaction is growing in China, and wring their hands about 'technical' levels for the RMB.  It's all so rich ... dissatisfaction is pretty high here too.

China has still $3t in reserves, generally a current account surplus, a net foreign creditor.  US has a money machine and it's using it to yank everyone else's chain.  Which set of circumstances is more sustainable?  Who's more vulnerable in the long run?

In reply to by pc_babe

new game ZoroAustrian Thu, 08/09/2018 - 21:34 Permalink

at 150b vs 500b, i think i'll go with the LARGE horse for the win...

by 350b furloughs

seriously this is about currency manipulation. pegged for how long?

pegged to fuk us! try looking back to see how this all came about.

and it could have been dealth with many tools available to congress.

but no- those fuks took their bribes(political donations, soft pac money) and sold the middle class down the 

shit creek. hello? fuk past and present congress and senators - oh and china too...

 

In reply to by ZoroAustrian

unklemunky ZoroAustrian Fri, 08/10/2018 - 08:23 Permalink

Uh,.....the Chinese economy is based on importing raw materials and exporting cheap shit to the US. They produce very little in the way of natural resources at home. As their market in the US begins to restrict its exports and its weakening currency lessens its ability to buy outside its borders, it will find itself all kinds of fucked.  You can poo poo the US all you want, but at the end of the day, the ultimate prize for the rest of the world is access to the US marketplace. Period.  We are the last bastion of free people on the planet. How free is arguable, but we are the most free and we have a consumer market economy not “state-capitalism” like the chinks do. So, do you place your bet on a free people or on a people who are crushed by an authoritarian communist government? Seems pretty clear to me.  

In reply to by ZoroAustrian

lock-stick lisa.roy39 Thu, 08/09/2018 - 22:35 Permalink

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In reply to by lisa.roy39

Clock Crasher Thu, 08/09/2018 - 20:43 Permalink

Why?  Cheap Yuan, strong dollar, cheap gold, use trade surplus dollars to buy devalued Gold.  

I don't see the problem.  

3D chess is no match for 5D chess. 

Hey... what do you mean the US is out of Gold?  What? Ahhhhh SHIT!

 

We send you toxic waste.  

You send us Gold.   

Hahaha

Davidduke2000 Thu, 08/09/2018 - 20:54 Permalink

These idiot experts are making a mountain out of a tiny hill as China sells only 16% of its global exports to the us and that represent only $1 trillion out of $6.5 trillion sales worldwide, and yet there is no evidence that the $ 1 trillion of sales to the us has diminished. as long as american companies are importing Chinese products, China keep shipping to trump's chagrin and the consumer will pay the new tariffs.

So these so-called experts expect the entire Asian market to blow up because trump is imposing taxes on his own people. 

Pathetic experts.

FreeEarCandy Thu, 08/09/2018 - 21:12 Permalink

No matter which way you look at it, China is either going to close down factories or have to buy more US goods with those very cheap Yuan to create a trade balance. If they choose to close down factories, then look a Detroit to see what that looks like.  If they choose to buy more US goods that they can't afford, then look at the US national debt to see what that looks like.

China was so aggressive they have eaten themselves out of house and home. They lost their appreciation for balance and harmony and now look what they have done. It is going to be painful to fix this mistake. The USA has already paid the pain price. Now in the second half it is China's turn to bite the bullet. Are they man enough to do what it takes to regain harmony?

 

A drop in the value of the yuan = a pay cut to every person in China. They are already working for peanuts. Slave labor has been the other leg of this disharmony problem. Perhaps raising their wages will solve all the other things, but if they drop the value of the yuan too much there will likely be a revolution. Correct the wage and subsidy problems, and drop all tariffs, and then you something that resembles an even playing field,

 

Imagine and economy were those who do the best are those that build the best, rather than one that exploits cheep labor and currency manipulations.

francis scott … FreeEarCandy Thu, 08/09/2018 - 23:15 Permalink

So you're spreading the lie that a devalued

currency at home raises the price of both

domestic and imported goods alike.

 

With our strong US dollar, in the last 2 months,

I've seen the price of Nabisco graham crackers

go from $3.00 to $4.00 a box and just last week

a 2 liter bottle of Pepsi went from $1.99 to $2.29.

 

Why inflation at home with a STRONG US dollar?

 

Because everything you just said about the weak

yuan was bullshit propaganda and you know it.

 

In reply to by FreeEarCandy

Jackprong Thu, 08/09/2018 - 21:21 Permalink

The Stable Genius Donald J. Trump, a Wharton MBA, knew that applying tariffs on Chinese goods sent to the U. S. the following would happen:

1)  The Chinese would devalue the Yuan to ease the impact of tariffs and make their products competitive in the U. S. resulting in little inflation to Americans;

2)  The resulting Yuan devaluation resulted in capital outflows from China inflicting pain on the Chinese economy;

3)  The income from tariffs will go to the Federal treasury that will strengthen government finances.

All that rubbish about Smoot-Hawley doesn't work in a floating currency environment.  Donald J. Trump is teaching us how these tariffs will benefit us and MAGA!

sekhars Thu, 08/09/2018 - 21:43 Permalink

fall in Yuan good for Chinese export. It was 6.8 in 2016 and is now it was almost 6 few months ago backing down again at 6.8 so not much of difference in 2 years time 

Yen Cross Thu, 08/09/2018 - 22:14 Permalink

  The Yuan ain't going much over (8) to $usd, or all hell is going to break loose.

 Watch the $usd weaken over the next week. All the $usd carry trade is hedged.

  Excluding the debacle today, the PBoC has been using the eur as a proxy to prop the $usd up.

 

 

Balance-Sheet Thu, 08/09/2018 - 22:28 Permalink

Just gear the tariffs to run autonomously. When the Yuan falls the tariffs jump an appropriate amount + a penalty for poor currency management. Then the Yuan can go to 20 to one USD, 200 to one, 2000 to one or a full Venezuela.

Simply make it clear that the outcome is balanced payments between China and the USA so skip the schemes- only the outcome matters.

Let it Go Thu, 08/09/2018 - 22:49 Permalink

A wild and crazy currency market should be flowing over and disrupting the stock market but things appear "magically stable" and the question is why. The argument that currencies are trading in a false paradigm extends past simple manipulation and is bolstered by their being sheltered from the storm of volatility by existing in a rather closed system. Wealth is trapped within the current system of fiat money by laws and rules that discourage freedom of movement into more tangible stores.

It is the coordinated collusion of the major central banks that have allowed this charade to exist. The fact it has not been recognized or acknowledged does not alter nor does it guarantee the system will continue. More on the subject of how this central part of our financial system may yet become unhinged in the article below.

 http://Currencies Continue Trading In False Paradigm html

roddy6667 Fri, 08/10/2018 - 02:33 Permalink

Lately the Yuan moved from 6.2:1 to 6.8:1.

Less than ten years ago the USD:RMB was 8:1.  China did not collapse. Trade did not die out. There was no tariff war, just business as usual. 

Business was thriving in China back then as it is now. The standard of living in all classes was rising. Things were good. They still are. 

The retards who write these articles interpret every blip in the market as a catastrophe. They have no memory of anything before last week.