August 13, 2015

Chinese Food for Thought

China is not a democracy. I say that to draw attention to the potential loss of credibility when the government controls the release of information. That said, this week the currency devaluation (i.e. selling the Yuan in the open market) that is being credited to the Chinese government is being disseminated by the media as, you guessed it, a crisis, and therefore the reason the stock market is declining. Well, given my recent comments regarding the much needed relief of a market correction underway, I don’t agree, and the following is why.

China is not alone in acting in the best interests of its economy at the expense of its trading partners. In particular the need to underprice America, has been a crucial strategy in the goal to expand Chinese consumers with purchasing power. That goal took Chinese “urban” households from 4% in 2000 to 68% in 2012.* Basically the Chinese government could maintain what appeared to be a stable and free floating currency while “pegging” it to the US dollar that had been falling since the financial crisis. The outcome of the strategy was the US struggled along the last five years while the Chinese economy grew handsomely, until now.

Smaller economies generally benefit the most from pegging their currency to the US dollar. However the downside to this activity is the country gives up control of its monetary policy. This is part of the problem that faced Greece in its recent crisis. And as China has moved away from manufacturing and transitioned to a service based economy it has felt the cold winds of declining productivity and inflation. Engaging in this US style (think quantitative easing) endeavor makes sense when deciding what China hopes to gain by devaluing its currency. Not to assure what little is left of export but to stimulate inflation, a much need measure of economic growth. It’s for this reason that the press in its simplistic fashion points to recession in China and the ensuing rattle of the markets follow. The importance of grappling with this logic is as stated above, as long as the government controls information there is a lack of credibility that I believe hinders an accurate scenario let alone an accurate projection.

But if one looks at the US, an economy that’s still nearly twice the size of China as measured by GDP, the lack of inflation has kept the Federal Reserve on the wall even as other areas of the economy have shown improvement. The outcome, has been modest growth that has kept the consumer busy with distractions such as rising Healthcare costs and sluggish wage growth. In my opinion China is more likely to follow the same course, bumpier but also easier because of the added consumer slack and capital resources in its arsenal to fight recession. And if the currency issue continues to be blown out of proportion consider that there is little evidence that domestic consumers feel the impact on imports from currency fluctuation. The resulting drops in interest rates and the US dollar are not yet ready to be dismissed as sympathetic movements, although I believe they are. And as far what little the US exports to China and its trading partners I honestly don’t think the Chinese consumer is going to let a little thing like a cheaper Yuan get in the way of owning a newer iPhone than their neighbor. Some things never change.