China's Real Problem: The Yuan

Lior Alkalay - INO.com Contributor - Forex


In the past few weeks, and especially this last one, equity investors watched in horror as China's stock market began to disintegrate. More than $3 trillion in value disappeared in what seems like the blink of an eye. Over the same period, the FX market has been preoccupied with the unfolding events in Greece. Many investors believe that, while Greece is very relevant to the FX market, China's problem pertain only to a bubbly stock market. If that's what you believe, too, you thought wrong! China's stock crash is a mere side effect of the country's real problem – the Chinese Yuan.

China's Ambition for the Yuan

The Yuan has always been a critical tool for Chinese policy makers. During the 1990s, China essentially sacrificed the Yuan in favor of growth as it aspired to become the world's factory. That thanks in large part was to a cheap labor force. Cheap labor is essentially only possible with an undervalued currency. The Chinese government succeeded in its endeavor. China rose to prominence, moving swiftly from a somewhat marginal economy to the world's second largest economy. There is no other way to describe it except as a phenomenal economic achievement and one skilfully executed.

China Annual GDP Growth

Now, Chinese leaders have reached their next resolution and are set to take the first step. Once again, the government’s resolve relates to the Yuan. In order to avert a Japanese style of rise and decline, China's government wants to do things differently. The government recognizes that it must turn the Yuan into a reserve currency, one that matches the dollar. This will allow China to turn into a more sustainable credit-driven economic model, à la the United States. Continue reading "China's Real Problem: The Yuan"

China: What Deflation Looks Like

By: Elliott Wave International

The Shanghai Composite fell another 8% at the open on Wednesday (July 8). Trading was soon halted by the authorities. (But for a different reason that the trading halt on the NYSE the same day.)

From its all-time high on June 12, China's main stock index is down 32%. Using the word "crash" is becoming appropriate.

"At the moment there is a mood of panic in the market and a large increase in irrational dumping of shares, causing a strain of liquidity in the stock market," said China's Securities Regulatory Commission on Wednesday (bold added).

But the "dumping of shares" is not the only type of selling that's going on in China right now. Bloomberg reports that (bold added), Continue reading "China: What Deflation Looks Like"

Chinese Stocks: "How to Think Like a Billionaire Investor"

By Elliott Wave International

With China's main Shanghai Composite index up almost 40% this year, and the tech-heavy Shenzhen Composite index up more than 90% YTD, are Chinese stocks in a bubble?

It's a legitimate question. You'll find many answers out there, but this answer you won't want to miss.

This answer comes from Elliott Wave International's own Mark Galasiewski, the editor of EWI's monthly Asian-Pacific Financial Forecast. Mark is on record for turning bullish on Chinese stocks almost a year ago, exactly on July 3, 2014. In that month's issue -- and at the time when almost no one was bullish on China -- Mark wrote:

"If the [Shanghai Composite] index breaks out above the upper channel line -- which runs through 2100 in July and which is about 2% above current levels -- then the multi-month uptrend that we have been expecting is likely under way."

Getting back to the question if Chinese stocks are in a bubble -- below, you'll find a link to a free special report where Mark gives you his answer in full detail. To give you a taste, here's an excerpt from Mark's June 2015 Asian-Pacific Financial Forecast: Continue reading "Chinese Stocks: "How to Think Like a Billionaire Investor""

3 Reasons Why This Week Could Be A Game Changer

Hello everyone, welcome to the beginning of a new trading week and what could be a game-changing week for the markets.

What stood out to me last week was the massive rally on Friday with the jobs numbers that were perceived to be better than expected. If that were not enough over the weekend, we had interest rates cut in China, with stocks over there rallying to the best levels in two weeks.

Here are the three reasons why I think stocks have the potential to go higher. Continue reading "3 Reasons Why This Week Could Be A Game Changer"

A Currency War? Think Again

Lior Alkalay - INO.com Contributor - Forex


More and more of the world's central banks are moving into negative interest rates and/or Quantitative Easing; the Bank of Japan has a massive ¥80 trillion in QE (per year), the European Central Bank with its estimated €1.1 trillion QE and negative deposit rates, the Swiss National Bank recently moving deep into negative territory, setting interest rates at -0.75% and now the Riksbanken, Sweden's central bank, following suit with interest rates set at -0.1%. And as this process escalates, two words dominate the commentaries: currency war. That word combination, so frequently bandied about by economists, financial analysts and media pundits, embodies the attempt by nations to devalue their currencies in order to increase exports and inflate demand. Yet despite headlines outlining how the currency war between nations can escalate inflation, in almost all major economies, inflation continues to plunge. The question is why? The answer might not only surprise you but put a question mark on the so called "currency war."

US and China Already Stopped "Playing"

One of the biggest facts that economists seem to ignore when warning of a currency war is that the world's two main players, the US and China – the two largest economies and arguably the two which started this so-called "war" – have long been out of the game. The US Federal Reserve Bank halted its massive QE program in October and allowed the US dollar to appreciate since then by more than 14% against the Euro and more than 10% against the Yen. Moreover, the Fed is seen as the only central bank that is seriously considering a rate hike, the total opposite of devaluation. China, meanwhile, perhaps the most aggressive currency manipulator in the world (with the US a close second), has not only stopped devaluating its currency but in fact has allowed its currency to appreciate so much that the Yuan has been the best performing currency in the world after the US dollar. The Yuan appreciated more than 8.5% against the Yen and roughly 12% against the Euro since October.

Although both countries aggressively manipulated their currency, their tools were somewhat different. The Federal Reserve used Quantitative Easing, which is essentially ballooning its balance sheet with printed money, a form of currency manipulation by any and all means. The People's Bank of China used to artificially lower the Yuan by purchasing dollars, which of course allowed its foreign reserves to balloon. Those were two very different methodologies, but the outcome was the same: the devaluation of the respective currency. Yet, as seen in the two charts below, China's foreign reserves have plunged by $105.5Bln from its peak and the balance sheet of the Federal Reserve has remained more or less stable, revolving around $4.4 trillion.


Chart courtesy of Tradingeconomics


Chart courtesy of the Federal Reserve

Why the War Ended

While the sense of an escalating currency war is looming in fact this war has aggressively de-escalated. Since 2007, the aggregate amount that the US and China injected into their respective economies amounted to a whopping $6.614 Trillion (not including other PBoC programs), an amount that dwarfs the current liquidity injections of the ECB, the BOJ and all the other central banks. One must wonder what is behind this dramatic change of heart which put an end to currency manipulation by the two biggest players. China, the more aggressive manipulator of the two, made a strategic decision; it no longer wants to be known as the "factory" to the rest of the world but rather it wants to become the world's largest consumer. Thus China allowed its currency to strengthen while lowering interest rates to encourage local consumption. In the US, the case was rather simple; the US has always been a consumer-oriented economy, and while it was hoped that US exports would eventually take the lead, it was actually the return of the American consumer that ended the need for devaluing the US currency.

What Could Trigger Another War?

PBoC Governor Zhou Xiaochuan has reiterated that they see no need to devalue the Yuan. As one might expect, it is inflation, yet again. While inflation in the US is stable in China it's taking a plunge, falling to 0.8% as of late. Although with interest rates at 5.35% the PBoC still has plenty of room to maneuver, one thing is clear and that is if things turn ugly in China and inflation turns into deflation, even after a rate cut, then China might go back to the good old tried and tested method of manipulating the currency. With China experiencing a prolonged deleveraging cycle, this risk exists. But until then, while the headlines may scream currency war, understand that it's a scare tactic. If anything, the currency war has dramatically de-escalated and if things don't deteriorate from here, it could mean that the currency war that everyone is busy screaming about has essentially ended.

Look for my post next week.

Best,
Lior Alkalay
INO.com Contributor - Forex

Disclosure: This article is the opinion of the contributor themselves. The contributor does have an interest in the USD/ILS rising as of the date of publication. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.