Suspicion grows that China is exporting deflation worldwide by driving down yuan
The Chinese Yuan weakened yet again this morning, punching through the key line of 6.25 against the dollar. It is almost back to where it was two years ago. This is the biggest story in the global currency markets.
Yuan devaluation has reached 3.1pc this year. The longer this goes on, the harder it is to accept Beijing’s story that it is one-off measure to teach speculators a lesson and curb hot money inflows.
The US Treasury clearly suspects that the Chinese authorities have reverted to their mercantilist tricks, driving down the exchange rate to keep struggling exporters afloat. Officials briefed journalists in Washington two weeks ago in very belligerent language.
The Treasury’s currency report this month accused China of trying to “impede” the market by boosting foreign reserves by $510bn last year to $3.8 trillion — “excessive by any measure”.
It gave a strong hint that China is disguising its reserve accumulation. You don’t have to dig hard. Simon Derrick from BNY Mellon said a recent buying spree of US Treasuries and agency debt by Belgium of all places looks like a Chinese front.
Holdings by entities in Belgium have jumped to $341bn from $169bn last August. This would appear to explain how China’s FX reserves have kept rising to $3.95 trillion even as its custody holdings in the US itself have been falling. If so, China is playing dirty pool.
Hans Redeker from Morgan Stanley says China seems to have adopted a “beggar thy neighbour policy” to counter the slowdown at home and soak up excess manufacturing capacity.
Albert Edwards from Societe Generale said in a note today that China is “sliding inexorably towards deflation”. Factory gate prices have been falling for 25 months in a row.
The GDP deflator — which proved a much better gauge of trouble at the onset of Japan’s Lost Decade than consumer prices — has plummeted from 1.4pc to 0.4 over the last year.
This means that China’s nominal GDP growth has dropped to just 7.4pc and is nearing the levels of the post-Lehman trough. This is the indicator that matters for the solvency of China’s heavily-indebted companies.
Mr Edwards said the next shoe to drop in world the economy (leaving aside the Donbass) is a systematic attempt by China to export its deflation to any other sucker willing to accept it by driving down the yuan.
Those countries that have failed to build adequate defences by keeping inflation safely above 1pc could face a nasty shock when this happens. The eurozone looks like the sucker of last resort. A Chinese deflationary tide would push Southern Europe over the edge.
Perhaps that is why the ECB’s Mario Draghi sounded ever more alarmed today in his efforts to talk down the euro today.
I take no view on how far China intends to go with this. It may reverse course any time. I merely pass on SocGen’s view for readers to think about.
Nor have I made up my mind whether the yuan is correctly valued. Diana Choyleva from Lombard Street Research says it is 15pc to 25pc overvalued as a result of surging wages and poor productivity growth....