Risk assets across the board are trading lower today after China devalued their currency, the renminbi (or “yuan” as it’s referred to in international context), overnight by 1.9%. China currently maintains a peg to the US dollar in order to keep the exchange rate in a very tight band. They do this by intervening each day to offset money flowing into or out of the country so it’s quite simple for them to adjust the target price by 1.9%. This was one of the major risks I identified in my letter to clients at the beginning of the year because it can create potentially devastating deflationary effects throughout the world. You can download my most recent letter to clients (July, 2015) here, and all past letters on my company website.
China has patiently sat on the sidelines (with the US) while most other countries have been in a race to devalue their currency because they’re trying to have the renminbi accepted as a reserve currency within the IMF’s Special Drawing Rights (SDR’s). Many emerging market nations are tired of the their capital flows and domestic economy being so closely tied to US financial policy since it causes such dramatic booms and busts. China has been working hard to enter agreements with other countries to perform trade in renminbi instead of US dollars, and are increasing the size of their government bond market since reserves are typically parked in bonds. However, their patience hasn’t paid off yet as they continue to be denied open acceptance in the global financial system (reserve currency status, stock index inclusion, etc.) for political reasons. And now their stock market, credit markets, and economy are contracting badly, forcing the government to devalue as a way to boost exports and hopefully stabilize the economy.
It will be very important to watch if China devalues again this year, or if they take a slow gradual approach (i.e. one devaluation of 2% per year), because the speed at which they do will determine the magnitude of the impact on the rest of the markets. China is the marginal buyer of just about everything so a devaluation hurts companies/countries that sell goods to China but helps Chinese exporters and companies that buy goods from China. This is why you’re seeing weakness in everything related to commodities, the global economy, and specific companies that have a large percentage of sales in China.
Fortunately, it gave us the opportunity to buy more stock in CF Industries today. Ask and you shall receive!
-Nick