The biggest global “tail risk” is China’s deteriorating economy and an emerging market debt crisis, according to BofA Merrill Lynch’s monthly poll of fund managers. And 48% of them were expecting the Fed to raise rates, despite languid growth and low inflation expectations.
Hot money is already fleeing emerging markets. Higher rates in the US will drain more capital out of countries that need it the most. It will pressure emerging market currencies and further increase the likelihood of a debt crisis in countries whose governments, banks, and corporations borrow in a currency other than their own.
This scenario would be bad enough for the emerging economies. But now China has devalued the yuan to stimulate its exports and thus its economy at the expense of others. And one thing has become clear on Wednesday: these struggling economies that compete with China are going to protect their exports against Chinese encroachment.
Hence a currency war.
It didn’t help that oil plunged nearly 5% to a new 6-year low, with WTI at $40.55 a barrel, after the EIA’s report of an “unexpected” crude oil inventory buildup in the US, now, during driving season when inventories are supposed to decline!
And copper dropped to $5,000 per ton for the first time since the Financial Crisis, down 20% so far this year. Copper is the ultimate industrial metal. China, which accounts for 45% of global copper consumption, is the bull’s eye of all the fretting about demand. 5,000 is the line in the sand. A big scary number. Other metals fared similarly.
Copper powerhouse Glencore, whose shares plunged nearly 10% on Wednesday, blamed “aggressive and synchronized large-scale short selling” for the copper debacle, instead of fundamentals. But fundamentals have been whacking copper for years, and shorts have simply been joyriding the trend.
Kazakhstan saw what’s happening to oil, its main export product, and to the currencies in China and Russia, its biggest trading partners. The yuan devaluation was relatively small, compared to the ruble, which is now allowed or encouraged to drop with oil. It has plunged 14% against the dollar over the past 30 days and 45% over the past 12 months, to 66.7 rubles to the dollar. With the Russian economy losing its grip, the ruble is dropping perilously close to the panic levels of last December and January.
And Kazakhstan freaked out and devalued the tenge by 4.5% on Wednesday, to 197.3 per dollar, the biggest drop since that infamous day in February 2014 when the central bank let the tenge plunge 20%. So that move is likely just a foretaste of what is still to come.[UPDATE – Thursday: It sure didn’t take long. The government abandoned the peg, and the tenge collapsed another 23% to 252 per dollar. Now that’s a real devaluation.]
The Turkish lira dropped 1.3% on Wednesday to a new record low of 2.93 per dollar, now down 4% since the yuan devaluation, and 8% for the past month. Turkey’s own political turmoil (to put it mildly) and proximity to a war zone are adding totally unneeded spice to the already difficult fundamentals in its economy and in the broader emerging market.
Vietnam lowered the reference rate by 1% on Wednesday and widened the reference band to 3% on either side. In response, the dong fell 1.2%. After similar devaluations in January and May, the dong is down 4.4% against the dollar for the year.
Then there’s Japan. Shinzo Abe had announced in late 2012, just before he came to power, that his official policy would be to crush the yen, and that he would get the Bank of Japan to do it for him. He succeeded wonderfully. Since then, the yen has lost 36% against the dollar, annihilating over a third of the yen-denominated wealth of the Japanese.
The shenanigans of the Bank of Japan have driven the Koreans nuts. The two countries compete directly with each other in numerous areas. And last year, Korea lost its patience and retaliated. Now China has added fuel to the fire. The Korean won is down 2.9% against the dollar in 30 days and 15% over the past 12 months.
The Indian rupee which had swooned badly during the Taper Tantrum in 2013, but then recovered, has been re-swooning starting a year ago and is now back to the Taper Tantrum levels of 65.2 rupees to the dollar, having lost another 1.5% since the yuan devaluation.
The Taiwanese dollar dropped 1.2% since the yuan devaluation; the Malaysian ringgit 2.7%, now down 6.4% for the month and 15% for the year. The Indonesian rupiah lost 1.4% since the yuan devaluation and is down 11% so far this year. Other Asian countries, such as Azerbaijan and Georgia, have already devalued their currencies over the past year.
But devaluations are not free lunches. They’re desperate measures that demolish domestic consumption and real incomes (see Japan), business investment, and overall credibility. And capital flees. They can also heat up inflation. But many emerging market countries and their banks and corporations borrow in other currencies to get access to lower interest rates. That foreign-currency debt can’t be devalued or inflated away.
Instead, the opposite happens. Their struggling or battered economies have to service foreign-currency debt with their own devalued currencies. Commodity exporters are getting sapped additionally by plunging commodity prices. Then that foreign currency debt, that cheap easy money everyone got to used playing with, becomes an insurmountable pile of expensive debt in a currency they can’t control and whose exchange rate might run away from them.
This is when a debt crisis begins to spiral elegantly through the emerging markets, taking down banks, entire economies, and gobs of investors as it goes – or taxpayers in other countries if there is a bailout. It’s always the same story. But this time, it’s different: after years of global QE, low interest rates, and hot money sloshing through the system, the sums are larger, and the risks are higher.
The start of a tsunami? Read… LEAKED: GM Sees Overcapacity Fiasco in China, Hopes Americans Will Buy Lots of Chinese-Made Buicks
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I have to give Marc Faber credit where it’s due.
Before Shinzo Abe was elected in 2012, Faber warned his newsletter readers a currency war was brewing and would erupt over the “next five-six years”. Faber saw the opening shots as being fired by both Sweden and Switzerland to keep their traditionally strong currencies undervalued relatively to the euro and hence help exports to their main customers (chiefly Germany and France). Faber also predicted there would be “casualties, and many of them”.
Few took notice, and Kuroda’s attack on the yen was long seen more as a way to steadily devalue the gargantuan yen-denominated debt (both sovereign and corporate) than as an old fashion attempt to fuel exports to Europe, the US and China.
When earlier this year the BNS was forced to abandon the euro-franc peg to avoid being crushed under the weight of euro-denominated assets, Faber’s prediction started to be taken seriously: far from simply conceding defeat, the BNS savagely slashed interest rates in a desperate attempt to obtain a “soft peg” with euro, which failed miserably as the Swiss currency is now inching towards parity with the euro. Inflation, something Swiss citizens are not accustomed to, is starting to heat up. Possibly worse, the BNS, which acts as a sort of “ultimate hedge fund” for the Cantons, has already announced large losses on its vast euro-denominated holdings, meaning the Cantons may for the first time in decades be force to deal with large budget deficits. The daggers are already out of the closet (I won’t delve into the idiosyncrasies of Swiss politics) and it’s safe to assume Switzerland will ironically be the first victim of Faber’s currency war.
But the true focal point of this brewing war will be Asia. With three enormous export-driven economies (China, Japan and South Korea) and many merchantilist minor powers (Malaysia, Indonesia, Taiwan etc) it’s here that the currency will be at its nastiest. Very much like the most important battle of the Thirty Years War (Rocroi) was fought in the Ardennes but the bulk of the war fell on what is now Germany, Asia will be the main war zone.
Most are aware China, Japan and South Korea all ultimately aim at increasing their exports to the US, but at the same time many ignore the huge volume of trade inside Asia proper: Taiwan sells semiconductors to China, China sells car parts to Japan, Japan sells textile fibers to Vietnam, Malaysia sells petrochemicals to Thailand… It’s on this “internal” Asian market that the currency war will become downright nasty.
China has fired what we may consider a warning shot. Japan, which has effectively been mobilizing for war for three years now, is bound to reply in kind. The 0.08% appreciation of the yuan we recently had is hardly a peacemaking effort on the PBOC’s part: if anything, it’s just a symptom PBOC officials aren’t as much in control of their own currency as they’d like everybody else to think.
Very much like everybody watched with baked breath what France was doing while Imperial, Bavarian, Swedish, Danish and Brandenburger armies hacked each other to pieces during the Thirty Years War, everybody is now looking at what the US Federal Reserve is doing. The FMOC is either throwing a highly effective smokescreen to conceal its intentions or is displaying a frankly disturbing lack of guidance for the committee overseeing the only remaining reserve currency in the world.
And here’s the kicker: the FMOC cannot tarry. By the year’s end at most they need to decide if they want to sit this one out (meaning no interest rate hikes but no further QE programs), join the war (meaning QE4) or reel the combatants in (meaning fast and decisive interest rate hikes).
Given the brand of indecisive leadership displayed by Janet Yellen so far, I fear she may opt for a compromise solution of baby step interest hikes which will literally cause more problems than the temper tantrums Wall Street would throw if rates were hiked by 2-3% right away and by similar figures every quarter until they reach a “normal” 6%.
We can only hope other FMOC members will display better judgement.
That was a very reasoned & informative post and addressed what I was annoyed with in the article which was the statement:
“This scenario would be bad enough for the emerging economies. But now China has devalued the yuan to stimulate its exports and thus its economy at the expense of others”
China has done what it had to do for it’s own economy & nothing more. It has sat back until now while all around it other major Asian currencies have devalued — a lot. it’s easy to blame China but the real blame should be sheeted home to the USA which started this whole mess the World is now in.
I think you must mean bated breath, not baked breath.
Why blame China for allegedly fire a warning shot when Wolf wrote that :
“Shinzo Abe had announced in late 2012, just before he came to power, that his official policy would be to crush the yen, and that he would get the Bank of Japan to do it for him. He succeeded wonderfully. Since then, the yen has lost 36% against the dollar, annihilating over a third of the yen-denominated wealth of the Japanese.”
As you can see it was Japan which fired the *first* warning shot 3 years ago, not China. And yet China kept the yuan stable for 3 years.
If someone fires a warning shot at you what would you do? Roll over and pretend to play dead?
Well foreign vacations just became a bargain.
True, just got back from Europe. Still, it’s hard to fathom why the same exact bag of Doritos costs 1/4 of the price in the Netherlands…
it’s hard to fathom anyone would eat Doritos.
Like I said in previous comments, dollar bull and Treasury bull.
I was listening to Fox Business News interview Donald Trump, what he is advocating is essentially a currency war with Asia using tariffs and trade agreements. Because he is gaining traction in the election, you can bet the others will jump on the band wagon, without even understanding what they are doing. It will be a long time before any of this unwinds but it looks like we will be backing protectionism big time. From globalism to protectionism will be a full swing of the pendulum. Hang on.
As much as it’s a big political topic, the US manufacturing industry has lot to lose from a trade war.
Yes, some sectors (consumer electronics for example) are dead or outsourced, but many others are still going strong. One of the curious facts I learned from my US friends is over half the wooden chopsticks used in China are manufactured in the US, especially in the South.
Protectionism and sanctions always invite retaliation in kind: as long as it’s a Pariah State involved, this may not mean much, but when it’s a big market like China, things can turn ugly really fast.
There’s another subtler problem at work. Mountains of cheap Chinese goods are what effectively saved Western consumers from a deadly combination of stagnating wages and unreported inflation. Close the gates to the them and outlets such as Walmart and Carrefour close shop… and where are the proles going to shop next? Somehow I seriously doubt a bicycle manufactured in Spain or Canada would be as cheap as the Made in China specials I see lined up in their hundreds at local outlets.
If we want to dig even deeper, those wind turbines governments and well connected corporations love so much are almost invariably manufactured in China and, ironically enough, shipped over here using Soviet vintage cargo aircraft. Again, made in China is the only thing making the present fascination with wind power possible.
The West and China need to man up and admit what nobody has the courage to say: each need the other to kick the can down the road a little longer.
It’s not about West vs China. It’s more the elites in both countries still need to kick the can until they are ready to pull out the rug.
Shutting down imports will also drive up the prices of items that are available, giving the fed the inflation they have been desperately seeking. Remember the last thing these guys care about is the people.
The fed hasn’t been seeking price inflation in commodities or prices in general but focused price inflation in assets that don’t enter those markets. Inflation in stocks and bonds (non-circulating inflation) if it enters the real economy and causes general price inflation would set off social discord. Palpable price inflation for the general population is highly undesirable to the ruling class and will only be seen as it loses control of it’s ability to direct its monetary inflation.
It is far fetched that the US can- or will ‘raise’ rates. Dollar flight into the US = falling longer term rates; the shorter rates are inelastic in as much as the central bank is already taking deposits and has been for awhile. There is little chance of escaping the liquidity trap.
What would be the effect if US rates rise? The Swiss central bank has lost billion€ in forex, the Fed would certainly lose more on its massive bond position. It can withstand the loss (central banks are always revenue neutral) but its finance clients cannot, the central banks are conduits both from and to the (bloated) finance sector. A rise in interest rates/decline in bond prices would smash the banks causing the very crisis the central bank is so desperate to avoid.
Consider 1937, when the Fed increased reserve requirements (and nothing else) the outcome was a 10% crash of US GDP. Tightening/monetary austerity is uncertain in effect … uncertain to the central bankers. Look to the EU to see how currency rigidity and tightening are playing out = bank runs leading to bail-ins. Now there are runs out of various currencies. Bankrupting trading partners by way of the forex markets is not how to revive overseas trade.
Also consider interest expense on US government debt. Last year the Treasury paid $430bn in interest. Doubling rates from the current, measly 1% to an also measly 2% = almost a trillion dollars, of course all of this increase would have to be borrowed. A greater increase would cause a ‘default’ in that the Treasury would have to issue US notes as the means of repayment. Don’t forget that $2 trillion platinum coin.
The right hand of the central banks work directly against the left hand. Consequently, the establishment’s ‘key man’ strategy of bailouts, easy low cost credit and the propping of key men such as stock and bond swindlers and real estate touts … has run its course. The deflationary impulse has been driven from manipulated share markets to currencies and commodities where the important transactions occur on Main Street, where the customers are tapped out and unable to borrow; where industries are unproductive, where the empty promises of ‘prosperity tomorrow’ are revealed to be worthless … and so is the money.
“Conservation by other Means™”; it isn’t pretty.
Historic monetary “bets” have been made not only by foreigners borrowing outside their home currency (think second and third world manufacturers borrowing in dollars) as well as others leveraging those moves by entering the derivative markets. This current “readjustment” which was made naturally and constantly by the many market participants in stable economies is being made artificially and therefore abruptly by a few in power. When the currency one earns in is being devalued faster than the one debts are owed in it becomes very difficult to manage those debts and some will sell at below sustainable prices (inventory dumping) to raise the currency to service those debts thereby handicapping producers who are still profitable dragging more into desperation selling. Purchasers and middlemen love this while it exists but as it rapidly consumes capital it ends with a crash.
The same is true but greatly magnified in the derivative markets. This behavior has been encouraged by the ruling class to stabilize the economic system allowing them to transfer wealth to those they deem “entitled” and to a greater degree, themselves thus allowing the perception of function at the increasing risk to the producing classes. If interest rates in US dollars were to increase in any way that would exacerbate this dynamic. Existing debts and derivatives don’t change when the economy or exchange rates do.
This, among other considerations, is why I agree strongly with Steve above. The Fed is talking this issue to death rather than acting. The certainly know better than any here that raising rates would be profoundly destabilizing worldwide and therefore unwelcome to our rulers. The economy lives longer but sicker when the bleeding is slow.
Meanwhile, on April 1st of this year, Canada and China started making direct currency deals, cutting out the USD middle man:
“There is a natural conflict between the U.S. dollar and the Chinese yuan,” said William Zhu, chief executive officer of Industrial and Commercial Bank of China Ltd.’s Canadian unit, the newly named clearing bank. “We should start in Canada.”
If China can get the yuan to be included as an SDR currency, then the camel will have its head well under the tent. It is not be totally inconceivable that the USD’s world reserve currency status could face a challenge.
Here is an additional thought, Rich:
The euro is currently the second most important world reserve currency. Before the euro debt crisis, it was on its way to approach the dollar’s importance, which was shrinking at the time. The debt crisis reversed that. Suddenly central banks holding euros realized what they had on their books.
So I think it would be broadly welcomed to see the yuan – currency of the 2nd largest economy in the world – not only become a top three reserve currency but also a top three trading currency. But all this will take years.
Wolf, for my own peace of mind, I’d like to believe that you are right on that time line, however, I fear that the Saudis may have other ideas. America’s highly leveraged fracking industry is severely hurting the Saudi economy. There is a new guy in charge over there, and he should want to punish the U.S. What better way than to kill the petrodollar, and, along with it, crash the junk bonds that are financing U.S. oil extraction.
The Saudis have surely been having some serious talks with the Chinese and the Russians, who are both less than satisfied with USD’s reserve currency status and the power of unlimited currency creation that goes with it.
The “power” of currency creation incldes the OBLIGATION to create currency and run trade deficits. Issuing the reserve currency cuts both ways.
I’ve returned 50% on Turkish Lira this year for a nice 5 figure return. Quite small but then again my allocation is only 20%.
The last 2 days have been brutal, the currency reaches 3 last night only to drop to 2.90 this morning. Perhaps I should go back to Asia to trade this thing.
“The shenanigans of the Bank of Japan have driven the Koreans nuts. The two countries compete directly with each other in numerous areas.” The Japanese have shot themselves in the foot trying to beggar their neighbor: raw materials and petroleum now cost 1/3 less for the Koreans, and they can offer 0% financing for consumers if Japan does. This is one reason they have been eating Japan’s lunch in areas that were unthinkable just a few years ago- high-end electronics, automobiles, etc.
How about Canadian dollar? Feel like my salary was 26% reduced in past 12 months. Possible additional 10% shaving if oil goes down more. Being of European origin can’t even think of going there for vacation or anywhere else since everything is priced in USA dollars and Euros.
The Kazakhstan devaluation was, in hindsight not so remarkable given the fall in the ruble. I may be wrong but I think it was basically catching up in dollar terms with the ruble, which I would think is their largest trading partner
I wonder where our critics disappeared to. Wait, I should have put 2and2 together: you can’t type if your hands were cut off by the falling knife. Duh!
Wolf, why blame China when you wrote that :
“Then there’s Japan. Shinzo Abe had announced in late 2012, just before he came to power, that his official policy would be to crush the yen, and that he would get the Bank of Japan to do it for him. He succeeded wonderfully. Since then, the yen has lost 36% against the dollar, annihilating over a third of the yen-denominated wealth of the Japanese.”
Therefore, IMHO the title of your piece should in fairness read “It Starts: Broad Retaliation Against Japan in Currency War”.
I think I started saying that a couple of years ago. Now it’s the rest of Asia’s turn.
Yes Wolf you sure did. But now you should, at the very least, give China some credit for keeping the yuan stable for 3 years after Abe trashed the yen to start a currency war in late 2012.
As members of the Fourth Estate, journalists must report the news accurately, sensitively and without bias.
IMHO, the title of your above piece puts the blame on China when it is Japan that is the recalcitrant.
No problem. I give China credit for keeping the yuan stable during crises in the past … and let it or make it rise against the dollar in the past. No problem with that. I think I pointed that out somewhere.
BTW, I don’t think I was blaming China. I was describing and analyzing a situation and the dynamics around it. I’m not a reporter. Not at all. I analyze and try to sort things out, try to make sense of them, try to put them into the larger context. And I add my point of view. This is not an algo writing these articles. This is me writing them :-]
Wolf, I did not say that you are not a reporter. From the facts you have an MBA, was the General Manager and COO of a large Ford dealership and its subsidiaries. Now you an author of two books, CEO of Wolf Street Corp., and a well-traveled journalist. The definition of a Journalist is this :
“A journalist is someone who investigates, collects and presents information as a news story. This can be presented through newspapers, magazines, radio, television and the internet. Journalists are relied upon to present news in a well-rounded, objective manner.”
So lets look at your claims:
1 “now China has devalued the yuan to stimulate its exports and thus its economy at the expense of others. ”
If the nuance escapes anyone, China is today the biggest trading nation in the world. It also purchases more commodities than any country. China was reported to have consumed more cement in the 21st century than the USA since 1776 and had imported more iron ores that the US, EU and Japan combined in 2011.
Therefore, a devaluation of the yuan is a double edged-sword. Its imports of commodities will be more expensive. How is that going to “stimulate its exports and thus its economy at the expense of others “?
A cheaper yuan means more expensive commodity prices for China. It is like cutting off her nose to spite her face.
2 “since the yuan devaluation; the Malaysian ringgit 2.7%, now down 6.4% for the month and 15% for the year. The Indonesian rupiah lost 1.4% since the yuan devaluation and is down 11% so far this year.”
These two countries are exporters of commodities that China cannot do without, such as palm oil, rubber, tin and spices. China is the main customer and not a competitor. Why should the approx 2% yuan devaluation spook them? Because Malaysia and Indonesia are competitors and the law of supply and demand applies.
3 “But many emerging market countries and their banks and corporations borrow in other currencies to get access to lower interest rates. That foreign-currency debt can’t be devalued or inflated away. Instead, the opposite happens. Their struggling or battered economies have to service foreign-currency debt with their own devalued currencies. ”
But who is artificially pushing up the US dollars ( and therefore EM countries’ foreign currency debt obligations) by manipulating paper gold and other precious metal prices? It is not China. It is the FED and its agent bullion banks. But we don’t see that in your piece, which implies that China is the cause of the woes of the EM countries. Enough said.
One final thought:
If China wishes to roil the markets she can sell the US$1.35 trillion US Treasury bonds and buy PM. That will push gold prices through the proverbial roof and the US dollar below the floor boards, causing US dollar interest rates to spike and that will unravel Wall Street and the $1,500 trillion Derivatives market. Will that happen? IMHO, it will if the West don’t stop manipulating the price of gold and silver and by extension the US$ 5 trillion forex market.
Correction : “Wolf, I did not say that you are a reporter.”