That has put the market focus back on a looming US rates increase. The complex structures of assets and liabilities that comprise markets are held together by a set of underlying beliefs.
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The weaker yuan will also add to the emerging market slowdown, with a potential long term impact on advanced economies.
China’s decision to devalue its currency has taken international markets by storm, raising concerns over a protracted currency war among the world’s leading economies.
However, another factor may also have been behind the central bank’s move.
The Australian dollar, battered last week given worries about China’s slowing demand for its commodities exports, was roughly flat against the U.S. dollar Monday. It’s easy to see why. This has implications for US sovereign yields, already on the way up with expectations of a rate hike by the Federal Reserve in 2015.
However, a country’s economic power and huge trade surplus is just one of the conditions for its currency to become an international reserve currency. Since that day, U.S. crude has fallen more than 12 percent. But this week, following the nearly 3 percent devaluation in China’s currency and a steepening decline in oil prices, it narrowed to its tightest in more than a month.
This unnatural and large-scale infusion of foreign credit into countries like the United States created a precarious spending spree among less productive economies. “From our point of view, the higher the cost to the Chinese for our raw materials, the better”. The practice, which is known as export preconversion, has been mainly conducted with Hong Kong counterparties. In the late 1980s, Japanese companies likewise boosted their profits with complex financial transactions known as zaitech.
Second-quarter earnings season is winding down. As the global carry trade retreats, foreign bank lending to China has collapsed – it’s down by around $250 billion over the last year, according to the BIS.
However, we think it unlikely that the Chinese government will let only market momentum drive the RMB exchange rate from now on, as that can be quite destabilising. Malaysian stocks suffered a 1.5 percent fall and the ringgit was stuck near a 17-year low. But it’s not clear whether this would be sufficient to offset tightening liquidity conditions.
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However, since some Western countries such as the UK and other EU members have ignored US opposition and gone ahead to join the AIIB, it could be said that there is greater international openness to the renminbi acting as a counterbalance to the dominance of the US dollar. Many large companies in the production space are quite leveraged, with debt-funded production capacities built up in the high-growth years. There goes the US’s chance at reforming itself and stopping to use monetary stimulus to fudge real economic deficiencies. U.S. stocks also rose, as investors looked to a modest but continued expansion in the U.S. economy.
