If Yuan Blood, You Got Yuan Devaluation

♠ Posted by Emmanuel in , at 8/12/2015 08:50:00 PM
1978-vintage AC/DC explains PRC currency moves.
Similar to the Swiss unpegging the franc from the euro earlier this year, the Chinese have surprised world markets by allowing their currency the yuan to devalue against the dollar after limiting its movements in recent years.  Yes, the Chinese economy has been moribund as demonstrated by the 8.1% drop in July exports, but market participants did not really expect such a drastic move since the PRC wanted to make the yuan more of an international reserve currency, and such drastic moves would generally discourage holding it. After all, why hold a depreciating yuan be considered a reserve asset? The PRC had stood by while others adopted easy money policies.

The initial move was announced on Tuesday. What's odd to me about that move is that stock markets around the world reacted so violently to China confirming what we already knew: its economy was slowing significantly and needed a boost of some sort. It devalued by nearly 2% and the People's Bank of China (PBoC) characterized it as a "one-off" that was to be followed anyway by more market determination of exchange rates--a "pro-market" move. But, surprise! Wednesday was greeted by a move of nearly similar magnitude pushing yuan depreciation to nearly 4% over two days.

Hence the AC-DC reference: yuan blood, you got...yuan devaluation. Asian stocks fell because business prospects in China where they do an ever-increasing amount of business were confirmed to be getting worse by the PBoC's action. European stocks have fallen the most since their recovery was increasingly dependent on China an an export market. US stocks have also fallen in sympathy, albeit with some recovery as I write.

It just goes to show how China is increasingly becoming important in the global economy--even in the equity markets that are frequently disconnected from reality. It is the world's second largest economy, after all. Since the start of the year (or slightly before), its slowing growth has had marked effects on commodity exports the world over. We are now finding out that it is an important export market for others' manufactured goods as well.

Hence, world markets are anxious to see what PRC authorities do with regard to currency. If the yuan slides more, well, I think you know what happens to world stock markets in the coming days.