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A new global currency war looks inevitable.
China’s currency, the yuan, continues to make news in recent days following last week’s surprise move by the People’s Bank of China to allow it to drop by as much as 4% against the world’s major currencies.
The move came as a surprise even to many veteran central bank watchers. The Chinese regulators have been trying very hard to regain credibility in the market after the sharp drop in stock prices in recent months. Hong Kong–Shanghai Stock Connect and the mutual recognition of funds with Hong Kong initiative were both long-expected measures aimed at attracting foreign investors and were finally implemented this year. Now the devaluation could potentially negate some or all of the benefits.
Many suspect the motivation behind the move was to smooth the path for the yuan to join the Special Drawing Rights (SDRs), the currency of the International Monetary Fund (IMF). Internationalization of its currency has always been on the top of the Chinese government’s agenda although it had pursued the objective in an extremely cautious fashion over the past decades.
The impact on global markets goes far beyond what meets the eye though given the scale of the Chinese economy as well the close ties it has forged with its global trade and investment partners. The most important and talked about potential outgrowth is whether this lowers the odds of a tightening by the US Federal Reserve this year. Goldman Sachs seems to think so. The rate hike is designed to combat inflation and prevent the economy from overheating. With a yuan devaluation, both possibilities are now less likely.
The less talked about but no less important side effect is the impact on the emerging market debt, which has already been suffering from the the strength of the US dollar. Yuan devaluation delivered another blow. An article published two months ago highlighted debt — especially emerging market debt — as the key risk in the global financial system. Without sounding like an alarmist, it feels like we have now set the timer on a bomb.
Currency traders went into panic mode last week, and most emerging market currencies have turned lower, with some, such as the Malaysian ringit and Turkish lira, down about 3% last week. As of this writing, Kazakhstan and Vietnam have also joined the ranks of nations devaluing their currencies. So the global currency war is not all hype. The race to the bottom may have just begun.
Below is a list of links from the paragraphs above as well as some of the other interesting reads I have come across in recent weeks. Happy reading and enjoy the weekend.
The Soft Side of Business
And Now for Some Readings Truly for the Weekend . . .
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: ©iStockphoto.com/Christian Mueller
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