China devalues (first shots in a trade war?)

[nmap]

1930s beggar-thy-neighbour fears as China devalues

China has begun to devalue the yuan for the first time in over a decade, raising fears that it will set off a 1930s-style race to the bottom and tip the global economy into an even deeper slump.


The central bank has shifted the central peg of its dollar band twice this week in a calculated move that suggests Beijing aims to offset the precipitous slide in Chinese manufacturing by trying to gain further export share abroad.

The futures markets are pricing in a 6pc devaluation over the next year. "This is clearly a big shift in policy and we are now on alert," said Simon Derrick, currency chief at the Bank of New York Mellon.

The move follows a Politburo speech by President Hu Jintao warning that China is "losing competitive edge in the world market".

China has allowed a crawling 20pc revaluation over the past three years. Any reversal risks setting off conflict with the incoming team of President-Elect Barack Obama in Washington. Mr Obama called China a "currency manipulator" during the campaign, a term that carries penalties under US trade law.

Outgoing US Treasury Secretary Hank Paulson is viewed as a "friend of China". He called for a stronger yuan this week before embarking on a visit to Beijing, but the plea was couched in friendly terms. This soft-peddling may soon change.

Hans Redeker, currency head at BNP Paribas, said China's policy switch could set off a dangerous chain of events. "If they play this beggar-thy-neighbour game, it will cause a deflationary shock for the whole world," he said.

It makes sense for countries with current account deficits such as the UK, US or Turkey to let their currencies fall, but China has the world's biggest trade surplus.

Michael Pettis, a professor at Beijing University, said it was "very worrying" that a pro-devalulation bloc seemed to be gaining the upper hand in the Communist Party. "I really do believe that we are on the brink of a very ugly period for trade relations," he said.

China has relied on exports to North America and Europe as its growth engine, making it acutely vulnerable to the contraction in global demand. Mr Pettis said this recalls the role played by the US in the 1920s, a parallel fraught with danger. "In the 1930s the US foolishly tried to dump capacity abroad, but the furious reaction of trading partners caused the strategy to misfire. China already seems to be in the process of engineering its own Smoot-Hawley," he said, referring to the infamous US Tariff Act in 1930.

China showed restraint during the Asian crisis in 1998, holding the line against domino devaluations across the region. It may yet hold the line this time.

However, this crisis is more serious. The manufacturing sector has seen the steepest decline since the records began, with devastation sweeping the textile, furniture and toy sectors. Civil unrest has begun to rock the Guangdong and Longnan regions.

Beijing has slashed rates and unveiled a fiscal stimulus of 14pc of GDP, but most of the spending comes in the form of instructions to local governments to spend more – but without giving them the money. Does China really intend to step in to prop up global demand? The jury is out.

LINK (http://www.telegraph.co.uk/finance/economics/3546471/Chinese-economy-1930s-beggar-thy-neighbour-fears-as-China-devalues.html)

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This has the potential to further damage U.S. and European exports - and Japan's as well.

If the big 3 U.S. car manufactureres cannot compete now, how can they compete if China devalues its currency, making their products even cheaper?

One U.S. response might be tariffs - which was the tactic that some suggest made the 1929 depression worse.

[Dozer523]

I'm going skiing in March - April. Doing the Haute Route. How do we talk the Europeans into do this to the Euro? Say 2 to the dollar? I just need it down for a few weeks!:p

[nmap]

I don't know about 2:1 Euros to dollars, but I came across an interesting blog you might consider looking at. Toward the lower end, it discusses the dollar and provides some charts. To make a long story short, it sounds as if you may get some very good deals in Europe. :lifter

LINK (http://economicedge.blogspot.com/2008/12/this-morning-i-received-following-email.html)

[Matta mile]

NMap,
Thanks for the info.

1. China owns more of us than most are willing to admit. Many of us stil think they are making party favors and tee shirts unfortunatly. A great attack and victory on an entire capitalistic nation without firing a shot IMHO as quality of life = the appox lowesr common denominator that provides goods in a global economy.
2. I was under the strong idea that the juan would be going up (not down) in value as per global census/tariff pressues. Seems this is not the case.
3. Assuming the juan goes down in value, will we be able to continue to borrow the money we do from them or will the price be higher?
MM

[nmap]

My pleasure, Sir.

China set itself up to be the workshop of the world - and so it is. There is a problem with that. We are vulnerable to disruption of our supply chain, at least in the civilian arena. I cannot help wondering what else has been compromised. For example, computer hardware and software could have vulnerabilities built in - these could provide access or disruption any time the creator wanted to do so. Even if we dismiss that possibility, the time and effort required to reconstitute the civilian production infrastructure could be substantial.

On your second point, the Chinese may have little choice but to devalue. Their economy is imploding - complete with riots at factories. LINK (http://www.google.com/hostednews/ap/article/ALeqM5jdt81rR7RGLIGuRTVkLQGOJxVZ3gD94MPOJG0). They have promised wealth and growth, they have increased the expectations of hundreds of millions. Can they control the results if they dash those expectations? Granted, the Chinese government can be ruthless - but I cannot help but wonder how much they can depend on the army to crush resistance.

Here's an excerpt from the WSJ:

Fast-rising unemployment has led to an unusual series of strikes and protests. Normally cautious government officials have offered quick concessions and talk openly of their worries about social unrest. Laid-off factory workers in Dongguan overturned patrol cars and clashed with police last Tuesday, and hundreds of taxis parked in front of a government office in nearby Chaozhou over the weekend, one of a series of driver protests.

On Wednesday, workers let go from a liquor factory in northern China mounted a protest in Beijing, at the parent company's headquarters. In the latest sign of economic stress, China's currency fell Monday by its single largest margin on record against the dollar, on expectations the central bank might devalue it to prop up sagging growth.

As the government tries to calm tensions in the cities, it also fears that newly unemployed migrants returning home could upend the already-strained social system in the countryside.



LINK (http://online.wsj.com/article/SB122816637753369999.html?mod=todays_us_nonsub_pag e_one)

And, too - if we press them too hard - they could simply sell our bonds in the open market. That would force interest rates higher and impair our ability to borrow. Expensive to them? Sure. But a sort of financial MAD strategy, perhaps.

If the Yuan continues down, we may be in a better position to borrow from them - after all, they will get more dollars, since they will export to us and receive more dollars. But in this, I think we face two problems.

First - at what point does the world market say "enough!". There are hints we're close to that point. Unfortunately, we won't know until bad things start to happen - bad things such as failure to sell the bonds we need to sell. Bad things like high interest rates.

The second problem is that both the U.S. and Europe still export some things. As the Yuan declines, our exports will be more expensive to others. Their exports will be cheaper. So market share will tend to move to the less expensive product...which hurts our manufacturing companies, which leads to more layoffs and bankrupt companies. Here's a Businessweek article that addresses the problem: LINK (http://www.businessweek.com/magazine/content/04_49/b3911401.htm)

This evening, I listened to a securities analyst who suggested that the dollar may fall briefly, but will then resume its trend up. He is a pure technician, so all he looks at are chart patterns. Anyway, from the standpoint of the consumer, we'll see some great deals. Likewise, those who travel will enjoy some bargains. On the other side of the equation, we as a nation may pay a price in terms of jobs, wages, and our manufacturing capability.