China’s Meddling Backfires

The Chinese government’s moves to push down its currency’s value and prop up its ailing stock market served one purpose: It told the world’s stock exchanges to panic, which they did in August.Imagine if free markets were allowed to be free. Of course, in today’s world, they’re not.  Central bankers and government agencies have taken control.  Not knowing what to do with markets hasn’t stopped them. We recently suggested that investors worry about China, not about Greece, although for a tiny country Greece gives everyone plenty to worry about.  And China showed us lately why it should be the center of everyone’s attention, with its inept attempt to fix its falling stock market and boost imports by devaluing the yuan.While it’s impossible to guess the intentions of China’s rulers – and they’re not about to share their plans – the devaluation, announced in mid-August, smacks of desperation.  China’s stock market has been swooning this summer and its exports are down by 8.3% (much larger than the expected 1.5% decrease), which is not good for future growth. Sure enough, the worldwide market rout followed.In addition, the Wall Street Journal noted, “Pockets of manufacturing have been especially hard hit, as reflected in sluggish electricity use and falling rail cargo. Especially scary is the prospect of deflation; producer prices were down 5.4% from a year ago.”China’s largest devaluation of the yuan in two decades will make exports cheaper for foreign consumers of Chinese goods, including Americans, but it will also reduce the purchasing power of Chinese consumers, who will likely consume less as a result.While officials claimed the devaluation is a one-time fix, under a new system of “daily fixes” (irony unintended), more may be coming. The Wall Street Journal cited three potential interpretations for the devaluation:The optimistic interpretation. China believes the yuan is overvalued, compared with the currencies of its trading partners, and its central bank is liberalizing controls to allow market forces to play a larger role in day-to-day trading.It’s the Fed’s fault. The U.S. Federal Reserve’s quantitative easing (a stimulus program where the Fed bought lots of bonds) “flooded the world with cheap dollar liquidity and now is poised to spark crises in emerging markets as it raises interest rates.” This would mean China is seeking to delink from the rising dollar more than it is trying to devalue the yuan.Join the currency war. China may be joining “the wave of beggar-thy-neighbor devaluations sweeping the region,” which could have a detrimental impact on both China’s growth and global economic growth.Regardless of the reason – or reasons – for the devaluation, it’s more likely to harm the economy than it is to help it.  When a country debases its currency, it typically causes economic pain, not economic gain.“Every country in modern human history has tried this,” investing website Hedgeye’s chief executive, Keith McCullough, said on “The Macro Show,” its video program. “You’ll note that it hasn’t worked.”For example, in 1997, after keeping their currencies stable for a decade, Thailand, Indonesia and South Korea each tried to devalue their way out of a crisis.“The result was a capital stampede that exhausted reserves and led to high inflation,” according to The Journal.  “Domestic institutions that had borrowed in dollars found themselves unable to service debts.  The dislocation damaged exports and their economies.”Consider some of the potential problems of the yuan devaluation. It likely will:Increase volatility and pressure on the Chinese currency.Discourage foreign investment.Encourage citizens to store savings abroad.Weaken consumer spending.Possibly result in contagion globally.“The devaluation has diminished the global buying power of Chinese savers by 1.9% at a stroke, which hardly encourages consumption,” the Journal concludes. “And it signals that manufacturers will continue to receive state support.”In the U.S., the devaluation could cause the Fed to continue to delay an interest rate increase. After all, the Beijing government’s action set off the events that triggered August’s global market swoon. William Dudley, president of the Federal Reserve Bank of New York, suggested publicly that the central bank may not enact a rate hike at its September meeting.As the New York Times noted, “The yen, the euro and several other major currencies have fallen in recent years against the dollar as the Federal Reserve has cut back its stimulus and policy makers elsewhere have sought to obtain gains for their sluggish national economies.”Follow AdviceIQ on Twitter at @adviceiq.Brenda P. Wenning is president of Wenning Investments LLC in Newton, Mass. AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty, including small businesses, doctors and clients of modest means, for example. Those with the biggest number of clients in a given specialty rank the highest. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. 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