The big news in the financial world last week was that China’s currency, the Yuan, fell by close to 2%. At first this doesn’t sound like big news. The Australian dollar has fallen almost a third over a 12 month period, something Australians have become accustomed to.
However, while Australia has a floating exchange rate since the 1980s, China’s is fixed. This means that its currency is pegged to the value of another currency (in China’s case, the USD) as determined by the Government.
Any moves in the value of China’s currency (because of the peg) are an active monetary policy decision by the Government to intervene in the market. Conversely, movements in the Australian dollar are a reflection of trade, and investors views about the relative performance of the Australian economy, exports, imports etc compared to other countries.
Last week’s movement in the currency initiated by Peoples Bank of China was the biggest seen in over two decades. So what does it mean for Australia’s exports? And what does it mean for the Chinese economy more broadly in the long term?
Another day, another conversation about China. There’s a pretty good reason why China is the focus of so much attention in financial markets.
China’s economy is restructuring.
Broadly speaking, this means that China is transitioning from a construction based, infrastructure-building phase of its economic growth to a more consumption-based economy. Most western economies have completed that transition early last century. This influences Australian markets for a very good reason.
Given China is moving away from a high labour and resource intense construction/infrastructure economy, they still need to balance growth, employment and financial stability as part of the process. Recent economic data (for July) suggests slowing industrial production, and fixed asset investment. The stock market is volatile and impacting consumer sentiment. It would seem a difficult juggling act.
This transition is why news about China influences Australian markets. Over time, China will need less commodities, and given they represent some 40-70% of global commodity demand… that is significant to Australia. Australia’s biggest trade partner is China, and we are a net exporter (predominantly of resources) to them. This transition is raising a lot of questions about Australian mining companies’ long term prospects.
China is not moving to a floating exchange rate like Australia, yet. The PBOC (also known affectionately as Big Moma) is making noises about wanting the exchange rate of the Yuan to better reflect market expectations.
A textbook economic analysis would suggest that devaluing your currency would give you a competitive advantage over other currencies, like the Yen, US Dollar, or Euro. This is because it makes Chinese exports cheaper and things that China imports more expensive. This gives an injection of life into the Chinese economy to help address underlying issues like its slowing growth rate and the volatility of the stock markets in China.
The currency fall in relative terms is nowhere near some of the other larger falls in recent times. In 1992 the British pound slipped 15% after when its price on the European Exchange rate Mechanism was overvalued. Much more dramatic currency plunges have been seen in Mexico in 1994, during the 1997 Asian Financial Crisis and several times through Argentina’s history… let alone what the Australian dollar has done over the last 12mths.
Instead, last week’s events have implications for the Australian economy and how we manage the transition of our biggest trading partner. China’s moves in the short term will put pressure on commodity prices as it becomes more expensive for them to import and pay in USD. Commodities that can be sourced within China (eg Coal) will be impacted the most in the short term. The Australian dollar will also be impacted as trade is impacted.
However more medium to longer term (and assuming the US and other economies do not try and neutralize the currency move) there should be better news for Australia, as China’s exports become cheaper and they require more resources to produce goods etc.
In the meantime, we might just have to tolerate some volatility in currency, commodities, and rates.
