China. Why we should be even more worried after the devaluation

It was the 27th of May, 2019, when Guo Shuqing, head of China’s banking and insurance regulator, said in a speech that speculators “shorting the yuan will inevitably suffer from a huge loss.”

On the night of the 4th of August, the People’s Bank Of China gave the green light to the third directed devaluation in the past five years. The onshore yuan finished the domestic session at 7.03 per dollar, its weakest level since March 2008, according to Reuters.

I find it amusing to read some analysts stating that the Chinese government’s stealth yuan devaluation has offset the impact of tariffs or will improve the economy.

A 10% tariff hurts a small part of the economy. However, a 10% devaluation hurts all Chinese citizens equally and massively.

China’s yuan devaluation is another proof that it is losing the so-called trade war, that its currency is far from “gold-backed” and that it follows the same misguided monetary policies of other fiat currencies. It is not a tool for competitiveness, but a shot in the foot

The yuan devaluation is not a tool for exports. Devaluations are a form of price control and a disguised reduction of salaries. As such, they hurt more than what they aim to protect.

However, with rising household and corporate debt. the yuan devaluation is a shot in the foot of the economy, as purchasing power is being diminished and loan repayment capacity is falling. It is wrong to believe that a devaluation does not pose a problem for debt incurred in yuan. Margins are falling because the yuan is devalued, but costs are not falling in tandem.70% of corporate costs do not fall with the yuan, they rise -energy,  fixed costs, imported goods and services-  and working capital requirements have been rising, as we have seen in the published earnings of most of the companies in the Shanghai Index. Around 65% of the index generates returns below the cost of capital and most companies pay interest charges with additional debt, according to Moody’s, and evident in the second quarter results published.

Household disposable income is also falling as inflation appears underestimated by official figures. Most independent analyses see real inflation closer to 2 percentage points higher than official data shows. Living costs have risen much faster than the headline inflation suggests, and the recent devaluations add to this problem, which makes debt-repayment capacity suffer with a weaker currency.

There are numerous reasons why we should worry about China’s decision to end its control of credit growth. The government has been encouraging riskier lending by cutting deposit reserve rates and pumping liquidity into the system.

The silent bailout, which has led to the PBOC injecting hundreds of billions of dollars into the financial system, is not reducing the excess risk-taking, it is encouraging it.

Industrial Production is showing evident signals of slowdown and fixed investment as well.

The housing bubble is clearly a threat and credit growth is losing steam.

China money supply growth exceeds the US one, while a significant part of fixed investment and credit goes to low productivity sectors or returns below the cost of capital.

The idea that the yuan is “gold-backed” clearly disappears when we look at the total gold reserves compared to money supply. Gold reserves are less than 0.25% of China’s money supply.

Unfortunately, China’s stealth devaluation is not making the country more competitive, it is making household and corporate debt riskier as the purchasing power of the yuan is diminished.

Meanwhile, foreign exchange reserves remain almost 20% below the peak level and the PBOC has abandoned its objective of fighting against excess debt.

The yuan devaluation is not solving the economy’s problems. By maintaining misguided capital controls and avoiding necessary structural reforms, the devaluation is accelerating the problems of the Chinese economy while hurting savers, workers, and pensioners in the country.


This is an update of my 26th August 2018 article.

For charts illustrating this article, see this Twitter thread.

About Daniel Lacalle

Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

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