Why China’s Currency Peg Can’t Last

China is understanding there are limits to monetary policy…especially after an historic credit boom. Bloomberg reports:

Is China’s latest monetary easing really going to help? While economists see it freeing up about 600 billion yuan ($96 billion), that assumes businesses and consumers want to borrow.

This chart may put some champagne corks back in. It shows demand for credit is waning even as money supply continues its steady climb.

The reserve ratio requirement cut "helps to raise loan supply, but loan demand may remain weak,” said Zhang Zhiwei, chief China economist at Deutsche Bank AG in Hong Kong. "We think the impact on the real economy is positive, but it is not enough to stabilize the economy.’

"Monetary stimulus of the real economy has not worked for several years," said Derek Scissors, a scholar at the American Enterprises Institute in Washington who focuses on Asia economics. "The obsession with monetary policy is a problem around the world, but only China has a money supply of $20 trillion.”

The problem China faces is only made worse by its peg to the US dollar. The last thing China needs is a strengthening currency. This erodes its export competitiveness against nations like Japan and South Korea.

At some point, I think China’s leadership will break the currency peg with the US dollar before the peg breaks them. This might be good for China, but it doesn’t bode well for the rest of the world. It will represent another crack in the global monetary system.

Late last week, the UK Telegraph painted an alarming picture of the effects of a potential yuan devaluation:

If this were to happen, it would send a deflationary impulse worldwide. China spent $5 trillion on fixed investment last year, more than Europe and America combined, increasing its overcapacity in everything from shipping to steels, chemicals and solar panels, to even more unmanageable levels.

A yuan devaluation would dump this on everybody else. It would come at a moment when Europe is already in deflation at -0.6pc, and when Britain and the US are fast exhausting their inflation buffers as well.

Such a shock would be extremely hard to combat. Interest rates are already zero across the developed world. Five-year bond yields are negative in six European countries. The 10-year Bund has dropped to 0.31. These are no longer just 14th century lows. They are unprecedented.

There are a lot of ‘unprecedented’ events going on in markets right now. It is this bewilderment and confusion that’s behind the ‘lack of confidence’ that seems to permeate many societies around the world.

We’re going to need a lot more than lower interest rates to get us out of the hole we’ve dug for ourselves over the past few decades.

The moment hath cometh to get out of the hole…or at least it’s surely on its way. But has anyone seen the man?

Regards,

Greg Canavan+
for Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

 


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