China Surprises with a Devaluation of Its Currency

What it means. How It Affects Your Money.

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China’s Devaluation Signals Important Trend

On August 17th, China announced a downward revaluation of the Yuan. The world seems very  concerned. While the US economy is doing about the same as it has been the last few years, the reality is the global economy is under a lot of pressure. Currencies are falling, recessions are breaking out and US export industries are already suffering.

Now China, which is number two in the world,  has taken the surprise measure of devaluation which can only mean they are under pressure too.

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Currency War Fears Over Yuan Devaluation: Reuters. How other countries are effected.

Surprisingly, China isn’t the cheapest place to make things anymore. In fact, right now labor in Mexico and a host of other countries  is cheaper than in China. Slowing economies and rising competition have caused China’s exports to decline 8% since last year. One remedy is to devalue their currency like so many other have.

How does a devaluation help their economy grow? If a Chinese worker is paid 10 yuan/hour that is $6.20. If the yuan should fall 10% against the dollar, that 10 yuan/hour worker now costs $5.58/hour lowering the cost of their products. By devaluing, the Chinese hope to sell for lower prices and beat out Vietnam and Mexico for export business.

China’s devaluation was a surprise,  but devaluations are common these days. Why in just the last year, both the Japanese yen and the Euro have devalued at least 15% vs. the dollar. But that’s not all. Many emerging countries’ currencies are at or near record lows and falling.

The world is worried that China will buy less and try to sell more. China is the second largest economy in the world now and its impact is very large. It is said that in the last 15 years China used more concrete than the United States did in the 20th century. It has been China’s huge demand for commodities and goods since the financial crisis that has had the most positive affect on the world economy. That is reversing.

Recent competition from  emerging countries with lower wages than China and the resultant drop in exports has forced it to devalue the Yuan. In turn others will be forced to devalue even more. Within hours of China’s announcement, Vietnam allowed their currency to devalue for the third time this year. If currencies are in competition to chase each other down, you may ask down to where? Well that is a good question.

The Good and Bad for the US

For Americans, in the near term at least, devaluations mean prices for imported goods and commodities will fall and a dollar will go further.  Now that China has joined the currency devaluation club, we may even see negative inflation for a time. Remember, exporting countries are competing for the same business. They may continue to devalue further and further to win business.

The stuff we buy at Target may get a little cheaper. This sounds great but there are two downsides. China and most everyone else isn’t going to be buying as much equipment, food or Harleys from us going forward. Our products are getting more expensive for them. Some people here will lose their jobs because of fewer exports.

International trade is going to pressure wages in the US as most of the world’s currencies are devaluing against the dollar and as a result their wages are falling in terms of dollars. In fact, increasingly this process is pressuring wages and business everywhere from Europe to Asia to Latin America, from Spain to Singapore.

Falling Currencies Have Triggered Defaults and Financial Crises Before

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The devaluations are increasing the risk of a debt crisis . Many commodity producing emerging economies, such as Brazil, Venezuela and South Africa, are falling into recessions and deficits and are particularly vulnerable. Commodities are at 15 year lows.  Brazil, a very large country, is particularly concerning. It has borrowed $billions to host the World Cup last year and the coming Summer Olympics. It isn’t being discussed in the media but this huge country’s reliance on commodity exports is killing them now.  They have both huge debts to pay in a back drop of huge economic and political problems.

Global Borrowings in Dollars is a Risk Now

Which brings up an important issue.  Emerging countries have accumulated record debts over the past 10 years and much of this has been borrowed in dollars, not their own currency. Devaluations mean  paying these debts is becoming more difficult.

Emerging economy recessions often do create crises. In 1997, Thailand’s currency crashed and subsequently a debt crisis broke out across Asia. Twelve months later, the crisis found its way to the US and the Federal Reserve had to intervene as a huge fund defaulted in New York threatening the entire financial system.

This time emerging market countries have about three times more debt than in 1997 and the majority of it is due in dollars. Having to repay debt in dollars isn’t a good thing right now. Remember many countries’ currencies are at or are nearing record lows. That means it takes more and more Thai Baht, Brazilian Reals or South African Rand to buy a dollar. The value of those countries debts is increasing as the dollar increases. Unfortunately, this is happening as their economies fall into recessions.

The Global Economy Seems More and More Important

The pressure globally on currencies, prices, wages and foreign economies does and will affect us in some good ways but potentially very bad ways as well. China is the world’s second largest economy and their announcement that they too want to devalue their currency shows they are worried about their own economy more than was expected. Most importantly, it accelerates the competition to devalue which in turn makes debts borrowed in dollars harder to repay.

We are one global super interconnected financial system now and how low is low enough for many currencies is yet to be seen and the consequences considered.

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