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"Austrian" Investment Themes, Economics

Chinese Currency Manipulation and the New “Giant Sucking Sound”

8622634_l (1)As Barron’s Up and Down Wall Street columnist Randall Forsyth wrote this weekend “for the currency markets, seven Chinese Yuan to the U.S. Dollar has become a milestone that seems as inevitable as Dow 20,000.”

For decades Chinese officials worked to keep the Yuan artificially cheap in an effort to boost an export driven economy. U.S. criticism of the  policy have come from both sides of the aisle including Barak Obama as both senator and president. 2012 Republican presidential nominee Mitt Romney vowed to label China a currency manipulator, and even the International Monetary Fund (IMF) criticized China’s currency “management” for over a decade.

For all the criticism however, little action was ever undertaken. Fast forward to 2016  and President-Elect Trump in addition to threatening to tear up trade deals has vowed to label China a currency manipulator on day one of his presidency.

It seems however that a funny thing happened on the way to the forex war.

In May of 2015 the IMF stated that the Chinese Yuan was no longer undervalued. Then just three months later global markets were rocked when Chines officials moved to devalue. While this move was undoubtedly a reaction to market forces already underway on the ground, the official move gave credibility and momentum to these forces, and to put it in terms that another billionaire businessman who once ran for president might use: you can hear a giant sucking sound as money is rushing out of China.

Of late, rather than manipulating the yuan lower, Chinese officials have been actively working to slow the depreciation.

Over the weekend a Wall Street Journal article noted that “China continued to squeeze the global market for the yuan Friday, sending the cost of borrowing the currency in overseas markets soaring to a near record high” and that “rates are likely to coninute as China’s central bank battles to keep the country’s currency from weakening too far and fast.”

Chinese officials have also been working to stem the tide of money rushing out of mainland China. According to Bloomberg the government recently “imposed a ban on foreing property purchases worth $1 billion or more by state-owned enterpises.” In addition “even the $50,000 that every individual is allowed to convert each calendar year can henceforth be used only for non-investment purposes such as travel or medical expenses.”

While China is thought to have substantial reserves to defend the value of the yuan, another WSJ reporter Linling Wei writes that “reserves appear to be less than abundant if gauged by…the ratio of the currency reserves to M2, or the broad money supply…based on this measure China should maintain between $2.13 and $4.26 trillion of currency reserves to fend off any destructive capital outflow.”

China’s current reserves stand at just over $3 trillion, but more importantly the central bank has (according to Wei’s article) “burned through about $1 trillion of the reserves in the past 17 months” and may not have enough reserves for a sustained defense of the currency.

So what does this mean for investors?

US Dollar to Chinese Yuan Exchange Rate ChartYou can start by rounding up the usual suspects of volatility and gold. In 2015 and early 2016 global markets took sharp dives at pockets of Chinese Yuan depreciation. This time around domestic markets have so far been firm, apparently inspired by the Trump rally, but things can change quickly.

In early 2016 in response to global market chaos tipped of by Chinese currency concerns, gold made a big run and while prices came back later in the year the rally was enough to break a three year losing streak for gold.

If the Chines do continue to defend or at least slow the yuan depreciation further depletion of reserves could also have an adverse impact on U.S. treasury rates.

The Trump – China relationship is certainly something that bears watching. As we have stated before even if the ultimate results of trade negotiations are mutually positive, Mr. Trump’s negotiating style is apt to ruffle some feathers and induce some turmoil along the way. Given Mr. Trumps public rhetoric about manipulations, and the fact that the Chinese have actually been working to support the Yuan, there is no telling just where trade “talks” may go.


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DISCLAIMER: Nothing in this article should be construed as a personal recommendation or advice. Nor should anything in this article be construed as an offer, or a solicitation of an offer, to sell or buy any investment security. Barnhart Investment Advisory clients and principals may hold positions in any securities mentioned in this article. Investors should conduct their own due diligence and seek the advice of a financial and/or investment professional before making any investment decisions.






  1. Pingback: Keep an Eye on China | The Austrian School of Investment Thought - August 3, 2017

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