Reading the renminbi runes

John Authers

China’s economic problems, rather than the PBoC, could drive a devaluation
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A commuter walks past the People's Bank Of China (PBOC) headquarters in the financial district of Beijing, China, on Friday, Sept. 12, 2014. Chinese Premier Li Keqiang’s options have narrowed: stimulate or miss his 2014 growth target. The weakest industrial-output expansion since the global financial crisis, and moderating investment and retail sales growth shown in data released Sept. 13, underscore the risks of a deepening economic slowdown led by a slumping property market. Photographer: Brent Lewin/Bloomberg©Bloomberg

“Whatever did he mean by that?” That, at least as far as folklore has it, is how the 19th century diplomat Metternich reacted to the death of his French counterpart Talleyrand.

Many of us have felt the same way as we tried to interpret this week’s events in China, as its highly managed currency suffered its greatest devaluation, of 1.9 per cent, in two decades.
 
That action was clear. It came the day after China had announced awful export numbers, with the long-time maker of almost everything the rest of the world wanted saying that exports had fallen 8 per cent, year on year. And so the first response was natural enough: this meant war, currency war.
 
Devaluing a currency makes its exports cheaper for others, and makes life harder for rival exporters. Plenty of different actors on the world scene have complained of currency wars and competitive devaluations over the years since the financial crisis, as exceptionally easy monetary policies kept currencies low. Now China — whose huge stack of foreign exchange reserves makes it uniquely able to enforce any given exchange rate — was joining in.

A wholesale Chinese devaluation has long been included in investors’ “nightmare” scenarios. When the renminbi opened down a further 1.6 per cent on Wednesday, that scary hypothesis appeared to be confirmed. And so we saw two days of sell-offs for almost anything that relied on selling to China (even Apple, which derives some 20 per cent of its sales from the country, was briefly negative for the year).

Then came a burst of signals. At the end of Wednesday’s trading, the renminbi rose 1 per cent — a move that in itself was bigger than any single day’s trading for the previous year. Then on Thursday, another fall at the opening was quickly cancelled out, by intervention, and the People’s Bank of China gave a rare press conference to try to make its intentions clear.
 
It presented the move as an attempt to ready the renminbi to move freely on world currency markets, and to form a part of the International Monetary Fund’s special drawing rights, an attempt to add market discipline to China. But it had no intention of leaving the currency to go wherever the market wanted it to go — market forces would almost certainly force it much lower at present — and was happy with its new level for now.

So that, it appears, is what the PBoC meant by that. As a result, Apple rebounded 5 per cent, bonds and gold sold off again and stocks recovered. By week’s end, most mainstream markets were much where they had started.

Central banks — and not just Chinese ones — are notoriously inscrutable. That is why a small industry exists to try to interpret them. But for now, the PBoC’s actions are consistent with its words. It is trying to hasten the introduction of its currency to the world system, while ensuring that it does not suffer any precipitate fall. If this turns out to be true, it ratchets up uncertainty and foreign exchange volatility, but it is in line with exactly what the rest of the world might want it to do. The calm response on bond, foreign exchange and stock markets shows that for now they accept this benign interpretation.

But other market signals suggest a different question remains, to which the answer is not necessarily benign. Commodity prices continue to fall. West Texas Intermediate crude, after signs of recovery, hit another post-crisis low this week, as did copper.
 
Those western stocks that derive most of their income from China continue to have a torrid time. With US companies almost having completed announcing their profits for the second quarter, only one sector has disappointed the forecasts set for it two months ago. That is industrials, the most directly exposed to China, where earnings are down 1.3 per cent year on year, according to Thomson Reuters.

According to Citi, the 48 largest developed market stocks that get at least 30 per cent of their sales from China have collectively fallen 10 per cent since June, while markets have generally been flat. And while the widely disbelieved official data show China’s gross domestic product growing at an annualised rate of 7 per cent in the second quarter, a host of measures of economic activity, such as rail freight, electricity production or housing starts, suggest outright decline.

China’s economy is plainly faring worse than hoped a year ago. Further, its attempt to reorient around services, and away from construction and exports, naturally mean that any slowdown may be felt worse among its suppliers abroad than it is at home.

This explains the fall in the price of the commodities China uses, and in the stocks and currencies of the nations that produce them, particularly large emerging markets such as Brazil, whose stock market has almost plumbed its worst depths from the 2008 crisis.

It is best to assume that the PBoC really means that it merely wants to bring market discipline to its currency and does not want to devalue; and instead to focus on the risk that problems in the Chinese economy end up forcing a devaluation anyway.

That is a more complicated question. Until it is answered, commodities, emerging markets and cyclical stocks will remain in the doldrums.

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