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.
