Upside for Currency Depreciation

China has recently allowed the yuan to depreciate past 7 yuan per dollar (D’Souza, 2019). Traditionally, China has never allowed the yuan to depreciate under 7 yuan to 1 dollar (Yeung and Huifeng, 2019). Traditionally, it has never made sense to. Having the yuan be so highly (some say too highly) evaluated has allowed Chinese investors to buy up companies, land, and investments across the planet, which is very useful for the rich and powerful of China, and friends of the powerful. A weak yuan destroys that buying power. It also weakens the attractiveness of the yuan as a trade currency, and to maintain current levels of lending requires larger amounts of yuan to match pre-existing U.S. dollar amounts.

Why does this matter? China has been pursuing an export strategy to increase the amount of capital in the country, which pays for the massive government programs that are underway. While a depreciating currency may be seen to reduce the profits made, it in turn makes goods cheaper.

Let’s say there is an American and a Chinese good of equal quality; both are $10 / 65RMB. The exchange rate is 6.5 yuan per dollar.

Now if China drops the yuan to 7 yuan per dollar, the new price is still 65RMB for domestic production costs, but the international price is $9.3. This makes the Chinese goods competitive, and they will sell more as long as stocks last.

Not only that, but if a Chinese worker costs 6,800RMB per worker per month (TradingEconomics, 2019a), then their international price is $1,046 per worker per month. But with a lower exchange rate of 7:1, the new international wage is $971 per worker per month. That’s about a 7.2% drop in cost for no difference in efficiency. This makes Chinese workers more competitive.

There is even discussion of reducing the exchange rate even further, to 7.2 yuan to a dollar (Yueng and Huifeng, 2019). This would reduce the international wage of Chinese workers to $944 per worker per month, which would be a 10% drop from the original rate; a bargain! It would also offset the U.S. 10% tariffs.

So Chinese workers become cheaper; Chinese factories become cheaper, and Chinese goods become cheaper. It also makes the foreign bonds held by China worth more money.

If you are a free market capitalist, you are also likely happy that China is providing goods and services cheaper, and that investment into China got cheaper as well.

We could expect a large increase into exports into the following countries: United States (minus that tariff business), Hong Kong (China), Japan, South Korea, Vietnam, Germany, India, Netherlands, and the United Kingdom (whose pound is depreciating, so maybe we won’t see cheaper goods) (World Bank, 2019). All of these countries will have cheaper goods for their own population (minus their personal currency issues).

There is also another rising advantage for farmers; as China is moving to feed its population without U.S. agriculture, other food producing countries are likely to benefit; chief among them being Brazil, Argentina, Myanmar, Thailand, Russia, Australia, New Zealand, Germany, France, and Spain. Countries who have to repay China in raw materials due to loans from One Belt One Road, such as food or metals, will now find it easier to repay China (Grill et al, 2019). In turn, this means that Chinese returns on loans may now lessen.

Also, with recent laws reducing the amount that a Chinese citizen can invest abroad, this currency devaluation will make the prospect less attractive (Yeung, 2019).



Downsides for Currency Depreciation

China is importing more and more meat, such as pork, and chicken, from abroad to make up for domestic shortfall due to disease in local animal herds. An unseen benefit to this is that China relies less on U.S. soy exports, as China now has less pigs to feed, thus giving a small relief to China’s side in the trade war (Chan, 2019).

Why is this worrying? Because increases in costs for food, unlike luxury or technology, are extremely inelastic in their change in demand; people cannot choose to not buy meat, and so an increase in price for meat is a decrease in the disposable income for Chinese people, who are already struggling to consume. This means that Chinese consumption will drop. China is now struggling to feed its population, and pork prices and food prices in general are inflating up to 40% y.o.y.

I’m not the only one to notice this; Premier Li KeQiang has said he will slice interest rates to boost consumption (Yeung, 2019). The problem is that Chinese citizens have higher and higher Engel co-efficients, and so an interest rate cut will boost the consumption of businesses and the rich, but I wonder how effective it will be on the middle-class and below?

The currency devaluation has a long-term side effect: if you are someone trying to bring jobs home to your country, then a Chinese public who 1) cannot buy your goods and 2) is now more competitive in wages is not a good sign for America. China having among the largest middle class in the world, as well as being a tourism exporter, are important customers for many markets. We shall explore this later in this article.

However, a sufficient weak yuan may end up hurting Chinese exporters as profits become non-existent with a weaker currency (Yeung and Huifeng, 2019). Not only that, but total new orders has decreased in the meantime (Reuters, 2019a). It seems that domestic demand alone cannot support the entire Chinese industry.

There is also another problem; during the credit crunch with the 2008 Financial Crisis, it was partly Chinese capital expenditure, loans, and deals that allowed the world economy to keep ticking (Grill et al., 2019). Should the world have a downturn now, China will have less ability to prevent or reduce a collapse with a weaker currency, as well as larger existing debts than 10 years ago.

Winners in the Slowdown

While the purchasing power of the Chinese consumer base has waned, anyone who has lived in China can guess the luxury goods which are doing well; foreign luxury cars, beers, and beauty products (McKinsey and Group, 2019). For the wealthy of China, these goods are quite inelastic in their purchasing habits; if you have the money, you get a foreign car, or Dior make-up. Ask a young Chinese woman about this: the fervour for foreign cosmetic goods above domestic goods is quite impressive.

Not only that, but half of new luxury consumers are new consumers in general; unaware of traditional or legacy luxury brands, they are also ripe for new brands to establish themselves in the Chinese market. Legacy brands cannot rely on that alone anymore (McKinsey and Group, 2019).

Another winner for this group; part of Li Ke’Qiang tax plan is a cut-down on luxury tax rates domestically, so the Chinese may begin buying domestically than abroad, which will help the Chinese market, and foreign brands indirectly (McKinsey and Group, 2019).

Another potential winner is China’s domestic stock market. With increased restrictions on foreign investment out of China, and Hong Kong suffering issues, the Chinese are preferring to invest domestically. The restrictions on capital movement away from China means that Chinese citizens will only be able to realistically invest within China, and the foreign investment is less attractive (Yueng, 2019). That means that more and more Chinese citizens shall place their savings wholly into the Chinese market, and be unable to move savings to other countries to provide diversity in their portfolios, and provide financial security. Good for Chinese companies, but I am reminded of the old tale of eggs and baskets.

There is an argument to be made, however, that the Chinese government forcing investment into the domestic stock market will help boost stock prices and domestic company funding (as choice is limited for the investor). As such, this could provide long-term capital supply for technological innovation, and therefore long-term growth.

Other issues involve increased political education by S.O.E.’s to their employees (Kawase, 2019). When companies spend more time focusing on non-profit seeking activities, it in turn reduces the total factor productivity of those companies, as companies work to align themselves with ‘Xi thought’ instead of business. The reason for this? The trade war is likely to cause the Chinese some stress, and the Chinese government has decided to tough out the difficulties, calling it the ‘New Long March’ agains the United States and this trade war. China is preparing for a long, dug-in economic war with the U.S., and it is beginning by ensuring the S.O.E.’s are in the trench (Perper, 2019).

Huawei’s CEO Ren Zhengfei: “We sacrificed [the interests of] individuals and families for the sake of an ideal, to stand at the top of the world” (Perper, 2019).

Of course, with all of the money printing focused on large Chinese state-owned enterprises, the S.O.E.’s continue to do well, as we have seen in previous articles. With the slowdown continuing, there are calls for further quantitative easing, which will help these companies further (Reuters, 2019a). Indeed; there has been a pick-up in onshore bond purchasing from local companies and governments (Reuters, 2019b).

Schrödinger’s Economy: Chinese market collapse?

China provides a lot of goods for a lot of people; China also sells a lot of goods for a lot of people. However, it is slowing down; for over a quarter, Chinese factory activity has dropped, as well as a small rise in unemployment over the same time period (Reuters, 2019a). However, even as trade slows down, the domestic service sector has been increasing and holding the fort for the Chinese (Reuters, 2019a). Not only that, but with a massive public debt based abroad (through One Belt, One Road), there is a small safety jacket placed on the Chinese economy as foreign repayments will continue to trickle into China.

If the Chinese economy were to collapse, one economist, Robing Xing of Morgan Stanley, predicts a global recession within 3 quarters (Yeung and Huifeng, 2019). Issues regarding Hong Kong also have seen a downward pressure on global growth, with Hong Kong being one of the global trade centres in Asia (Bloomberg, 2019a).

The Chinese economy is also very tightly linked with all of it’s neighbours, as we have seen. As such, we have seen a drop in the currencies of China’s neighbours, such as South Korea and India.

One of the biggest drivers of growth in China are the young (McKinsey and Group, 2019). Watch them; if they stop buying, we’re in trouble. One of the largest areas in which they purchase heavily are luxury goods. Notice also that China is perhaps one of the largest consumers of luxury goods; Chinese consumers are estimated to buy 65% of the world’s additional luxury goods by 2025 (or 40% in total); they already represent a third of all luxury spending (despite being a fifth of the planet, meaning they are punching above their weight) at $115 billion in 2018 (McKinsey and Company, 2019).

The young are optimistic; many new graduates are delaying their graduation by a year to avoid this market, and because they believe that the economy shall be better in a year (Bloomberg, 2019b).

However, the young have many upcoming problems; housing, healthcare, education, all of which are generally seen as inelastic (I mean, not many people will choose to let people die over saving money) which all drive down that spending.

So Is The Chinese Economy Really Slowing Down?

Yes. This isn’t in debate at all, even the most pro-Chinese economist admits this. The real question is how much.

It’s not unknown that the real GDP figures are false, and even a quick examination of the numbers will prove this. The Chinese government itself only uses GDP as a measure of assuring growth to the people. A metric used by the Chinese government is the Li Ke’Qiang Index; an alternate measurement that is less likely to be manipulated: