This Week's Focus: Something is happening in China

This Week's Focus: Something is happening in China


During the second half of August, the Chinese stock market plummeted while the central bank revalued its currency against the US dollar. Both factors infected all financial markets, both equity and bonds, in what has been termed as "black Monday". Since August is a month of little activity on markets, amplification of sudden movements usual, but the magnitude and breadth of happened this summer have raised fears that the correction can last if the underlying factors materialize.

In short, the causes lie in: the possible initiation of a "currency war" among Asian countries to earn foreign competitiveness, a sharp contraction of the economy in China and the coincidence with the beginning of the interest rate hikes by of the US Fed.

The depreciation of the yuan
China decided to relax the yuan exchange with some surprise to the markets, allowing an initial 3% depreciation against the US dollar in just three days. The reasons may be behind are:

China wants its currency to become "reserve currency" that is integrated into the basket of currencies that make up the Special Drawing Rights (SDR or by its acronym in English), with which the international multilateral lending institutions are granted as the IMF or the World Bank. The aspiration of China happens to have more weight in the Steering Committees of these international organizations. A prerequisite for the Yuan to be moenda book is that its exchange rate is flexible to market conditions, rather than rigid and controlled by a central bank.

On the other hand, the yuan has appreciated strongly against the currencies of its main trading partners (+ 21% over the last 3 years), representing a loss of external competitiveness relative to other Asian countries (Korea, Indonesia, etc.) that if they have seen its currency depreciate. Therefore, the movement tries to compensate in part for this purpose, although it can not be described as far from competitive devaluation. It should be much more pronounced for lost ground and, after the G20 meeting, has stated that they will not take action in this regard, but will prevent a spiral of devaluations in Asian countries (including China ) that produce a deflationary effect on the world.

Although foreign debt in USD in China is much lower than its foreign exchange reserves (China has 3.6 billion USD in its currency reserves, while the debt of Chinese companies is USD 1.2 billion), alsoIt would have looked ease monetary conditions in the face of expected rate hikes from the Fed. These increases probably appreciate the USD against all currencies, not just the yuan.

Slowdown yes, but not recession
China is causing a transition of its economic model, is not anything new or unwanted. In an economy based on production for export manufcaturera economy, you want to go towards a model of more domestic consumption and value added. This is not done quickly and the risk of mismatches on the road is high.

The interpretation of the depreciation of the Yuan as evidence of the collapse of the Chinese economy, seeking to gain external competitiveness perpetuating the old model is probably something wrong.

Numerous measures of monetary and fiscal stimulus seeking a growth stabilized at a level consistent with an official figure of 6.5% from rates of over 7% annually. Some sectors, such as residential construction fall hard, but increase investment in infrastructure and the growth of disposable income and service sector remains. The impact on commodity demand has been reflected in their prices, leading to sharply lower growth in exporting countries such inputs (Brazil, Peru, Australia ...)

Slowing growth in China will have a moderate impact on the global economy, unless new unexpected elements. Inflation will remain moderate, which can lead to the central banks of the developed countries (mainly to Europe and Japan) to maintain expansionary monetary policies for longer, with unusually low interest rates and money creation in high rates .

Impact in other advanced economies
In this context, monetary normalization in the United States may not be as steep as the market discounted in previous months, although it seems very close to the first rate hike. Another thing is the pace and intensity with which the Fed continue its path of normalization, which can last more time.

In any case, the effects of slower growth in China seem unimportant to USA and Europe. Direct exposure to China is low: less than 10% of extra-EU exports have final destination in China, and the figure is lower in the US.

On the other hand, the slowdown in Europe and North America to China and other emerging countries exports will be offset by the lower cost of raw materials is likely to continue in segments with clear overcapacity (steel or building materials)

UBS estimates that, for every 1% that the economy will slow Chinese-and including the effect induced in the rest of the world GDP in the Euro Zone would suffer by 0.2% -0.4%.