We do not have a snowball’s hope of fighting the currency war
The Bank of China jumps a surprise on the rest of the world by officially depreciating its currency, the Yuan two days in a row and markets go into convulsions. Surprisingly, the Rand does not perform too poorly, losing only some 0.4% against the American dollar after the Bank of China’s announcement.
The JSE Allshare index also held up well hovering just above 51000 index points but still a long way off from the lofty 55,000 in April this year.
The Yuan now officially trades for Yuan6.23 to the American dollar, some 2% lower than the official exchange rate a week ago. By week’s end, some stability returned to international markets but investors were spooked and remained cautious of Chinese assets. Both the Hang Seng index and the Shanghai index were down to levels last seen in March this year, while trading remained thin following the Chinese government’s intervention two weeks ago, which saw trading in a number of shares suspended.
The latest move by Chinese financial authorities, in my mind, will go down in history as the official beginning of the much-discussed currency war. The first shots in this perceived war were fired more than two years ago when the European Central Bank started its own version of quantitative easing, and the Japanese government stated its intention to devalue the Yen to boost inflation. But none of these first strategic moves to devalue two of the world’s leading trade currencies were ever stated to be a direct attempt at devaluation. There was always some other excuse or policy for creating excessive liquidity never stating openly that the sole intention was to devalue. Still the devaluation started and still continues.
Now the Chinese authorities have reshuffled the pack, stating openly it is their intention to devalue the Yuan and then following up with directed action. In the process they ruffled the feathers of almost every other central bank in the world.
The unresponsive local markets provide us with some respite but I do believe this will be brief, in fact less than a month.
For some time now, the US Federal Reserve has prepared the way for a rise in interest rates. A Wall Street Journal poll found this week that an overwhelming majority of players in the American financial services industry, believes the Fed will actually start raising interest rates in September. This opens another can of worms for Third World central banks as it is a widely held point of view that emerging market currencies will depreciate once US Dollar interest rates rise, unless they stay ahead of the curve by raising domestic rates before the Fed can make its move. This scenario is evident both in Namibia and in South Africa.
But after this week’s Yuan depreciation, the interest rate curve is no longer as clear as many would like to believe. Many analysts point out that a rise in US interest rates will lead to an appreciating US Dollar, some even saying that a fractional increase of only 0.1 percentage point, will have an impact the world over. This may be an exaggeration, but an 0.25 percentage point increase will certainly produce some ramification before reason sets in again.
A US interest rate increase will probably also pop the reigning bond bubble, leading to higher bond yields but eroding the capital base of those investors who got into bonds when they were at their most expensive. Again, this outcome is not certain and the bond rally earlier this week should caution analysts and investors alike that in these extraordinary markets, nothing performs as the computer model says it is supposed to.
Perhaps the only reasonable course of action on our side is not to pick sides. And by our side, I include the South African economy because the entire combined SADC economy is simply too small to make any dent in the direction the large currencies take. It is also an exercise in futility to think we can hedge ourselves in some way. The only rational response is to be very wary and shift investments or adjust portfolios only after exercising great caution.
The Chinese government may be our new best friend but seeing the equanimity with which they depreciated their currency, I do not think we must be fooled to expect our continent’s future will play any role when they go for their second round of devaluation.
That is about the only thing that seems certain to me. The currency war has started and no other central bank will put African interests before their own. With these very large economies, they will do “whatever it takes” to gain a small advantage over their competitors, bugger Africa.