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.

4 thoughts on “China. Why we should be even more worried after the devaluation

  1. Hi Daniel. Thanks for your always insightful views. I live in South Africa so currency devaluation and own goals is not a foreign concept unfortunately! I am struggling to understand two things which I would really appreciate an explanation on if you have the time. Firstly you talk about debt being more difficult to pay off when the CNY depreciates. Doesn’t the deval effectively cause inflation which is good for debt repayment (or are you referring to USD debt which is a small percentage of total Chinese debt). Deflation generally leads to default if looked at in local currency terms right?

    Then just understanding the point around devaluation being a tool for chrony capitalism. Does a weak currency not help build a nation (If it doesn’t get out of hand of course) since it can export more meaning the current account is rebalanced. Or of there are 10 people in a country and currency devalues, only 2 would benefit and 8 would suffer kind of thing?

    Thank you. I am a big fan of your work and it’s inspiring to see a traditional economist being able to apply his knowledge so practically.

    1. Dear Phil

      The myth that inflation effectively cancels debt or helps repay it is debunked by the rising cost of imports, weaker disposable income of the indebted and, as such weaker repayment capacity.

      The myth of devaluation as a tool for exports has been also debunked in an open monetary system. Exports do not rise because of devaluation. Venezuela or Argentina would be kings of exports if it was the case.

      Those are ideas that have been repeated when economies were closed and less complex. Open economies debunk the fallacy of devaluation as a magic solution.

      Thanks for following

  2. Of course, the devaluation of the yuan is not about winning the trade war with the US, and it is a form of price control. And of course the Yuan is a fiat currency right now.
      But although the US is a very important trading partner of China, the US is not the only one. And almost all other trading partners have devalued their currencies too and even more than the Yuan. China has been accumulating their gold position to a significant extent for some time. And in my opinion it will be a matter of timing when China and other countries will support their currencies with gold.

    1. Dear friend,

      I disagree.

      China’s entire gold reserves are less than 0.3% of money supply. The myth of the gold-backed yuan is as unreal as the myth of the gold-backed euro or US dollar. However, money supply growth in China is 3x higher than in the US with weaker demand of yuan (used in less than 4% of global transactions and suffering capital outflows).

      Thanks for the comment and for following.

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