August 13, 2015
China's Doing Yellen's Job and Creating a Trillion Dollar Profit Pivot
by Keith Fitz-Gerald
Despite what the markets seem to think and many news sources would have you believe, China's move to devalue the yuan by 1.9% is not an act of desperation intended to prop up a failing economy. It's not a surprise. And, it sure as heck is not the end of the financial universe as we know it.
Instead, it's a brilliant move that singlehandedly changes the investing landscape and creates a fabulous new set of profits if you've got the guts and the smarts to make your move.
Today we're going to talk about why and, as always, what makes the situation so very appealing and so potentially profitable at the same time.
As always, I've got a few specific recommendations to get you started.
Let's begin by talking about what Beijing did and why I believe this is a major move that changes the investing landscape.
This is the biggest currency adjustment Beijing's made in 20 years and it's the biggest single drop since 1994 when China ended the old dual currency system.
On the surface, the 1.9% decrease in that nation's central bank "reference rate" is designed to support exporters and boost market pricing in China. Western analysts view it as a threat because it's clearly more "price fixing" on China's behalf.
What they don't understand is that China's been propping up the yuan for years to guard against capital outflows, to protect foreign currency borrowers and to stabilize the yuan's role in global trade as a potential reserve currency for the International Monetary Fund. If you think China's got too much power now, imagine what the world would have looked like today if that nation had not restrained its currency.
Dropping the yuan is actually a means of making room for market-based pricing.
I've long counselled that Washington had better be careful what it wished for when it accused China of currency manipulation, specifically because of the kind of reaction that's happening today.
Contrary to what Washington would have you believe about China's currency being undervalued, the yuan's real effective exchange rate has risen by 33% over the past four quarters, according to the Bank of International Settlements. In fact, the growth was so high and so fast that it was the single fastest appreciation move and the highest among 32 major global currencies tracked as reported by Bloomberg.
Dropping the yuan is not only logical, but part of the path China has to take to make its currency fully convertible.
In the old days, China would simply set a peg rate to the dollar that - love it or hate it - was completely arbitrary. Hence the currency manipulation allegations.
But now - effective immediately - market makers who submit prices to the People's Bank of China as part of the reference rate have to take the prior day's closing spot exchange rate into consideration, foreign exchange supply and demand, AND changes in major currency rates. In other words, market-based pricing.
This is exactly what's required by the IMF for reserve status - that a currency be freely usable and market driven.
China's Attack on the Greenback
The other thing that stands out about this move is that China is doing Yellen's job. You're not hearing about that... yet. But you will.
Classic economic theory dictates that a stronger dollar makes U.S. exports weaken, imports cheapen, devalues overseas profits, and brings about a sharp increase in domestic labor cost. By any measure, it's a restrictive economic policy which is why the Fed has so far refused to raise rates and - with a straight face - been able to sell their zero interest rate policies for so long.
The problem is that sooner or later the markets always fix things themselves.
China's move immediately makes the dollar stronger. That, in turn, further hamstrings U.S. exporters and worsens the trade imbalance with China. It also shifts the competitive advantage to Beijing.
Theoretically, Team Yellen would have addressed this by shifting the advantage to the United States with a rate increase long ago. Instead, what we got was more of the same - a totally inept sequence of fiscal blunders, stimulus and a "data-driven" Fed that's scared of its own shadow.
China simply took matters into its own hands.
