“Nature does not hurry, yet everything is accomplished.’
Many analysts have been predicting China will “weaponize” its currency; i.e. push it sharply lower against the US dollar as punishment for US trade “aggression.” On first blush, this sounds sensible. But I don’t believe it aligns with what China is trying to accomplish with its currency; and in fac, it would be a very risky strategy near-term.
Two things seem clear:
- Over time, China wants its currency to displace the US dollar as the world reserve currency. Granted, this is a long-term process. But thinking strategically, as we know Chinese leaders tend to do, a volatile currency based on whim and retaliation would not benefit ongoing objectives of having countries settle trade with China in yuan (renminbi); i.e. they want to build a stable track record aligned with the ongoing development of Belt and Road is my guess.
- A big devaluation would lead to capital running from China as fast as it can. We have seen this before. When China devalued its currency (or it fell sharply against the US dollar) between 2014 and 2016 capital flow turn negative in a big way for China.
Though it is not showing up on this chart, we know capital has been running out of China. President Xi risks an avalanche of funds running from his country if he decides the currency is the tool to blunt US “aggression.” Granted, capital controls would be strict, but leakage would happen nonetheless.
And one more chart to note. A bit complicated but some key points:
- China’s relative yield spread is now rising against the US (blue)
- Emerging market stocks (purple) are tracking on China’s currency (gold); so, if you buy into the appreciating yuan theme, EEM is cheap longer term.
- The Australian dollar (green) appears extremely cheap if the yuan appreciates (yes, we are long Aussie and took off some s/t profits there yesterday).
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