Wolf Richter: It Starts – Broad Retaliation Against China in Currency War

By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street.

The biggest global “tail risk” is China’s deteriorating economy and an emerging market debt crisis, according to BofA Merrill Lynch’s monthly poll of fund managers. And 48% of them were expecting the Fed to raise rates, despite languid growth and low inflation expectations.

Hot money is already fleeing emerging markets. Higher rates in the US will drain more capital out of countries that need it the most. It will pressure emerging market currencies and further increase the likelihood of a debt crisis in countries whose governments, banks, and corporations borrow in a currency other than their own.

This scenario would be bad enough for the emerging economies. But now China has devalued the yuan to stimulate its exports and thus its economy at the expense of others. And one thing has become clear today: these struggling economies that compete with China are going to protect their exports against Chinese encroachment.

Hence a currency war.

It didn’t help that oil plunged nearly 5% to a new 6-year low, with WTI at $40.55 a barrel, after the EIA’s report of an “unexpected” crude oil inventory buildup in the US, now, during driving season when inventories are supposed to decline!

And copper dropped to $5,000 per ton for the first time since the Financial Crisis, down 20% so far this year. Copper is the ultimate industrial metal. China, which accounts for 45% of global copper consumption, is the bull’s eye of all the fretting about demand. 5,000 is the line in the sand. A big scary number. Other metals fared similarly.

Copper powerhouse Glencore, whose shares plunged nearly 10% today, blamed “aggressive and synchronized large-scale short selling” for the copper debacle, instead of fundamentals. But fundamentals have been whacking copper for years, and shorts have simply been joyriding the trend.

Kazakhstan saw what’s happening to oil, its main export product, and to the currencies in China and Russia, its biggest trading partners. The yuan devaluation was relatively small, compared to the ruble, which is now allowed or encouraged to drop with oil. It has plunged 14% against the dollar over the past 30 days and 45% over the past 12 months, to 66.7 rubles to the dollar. With the Russian economy losing its grip, the ruble is dropping perilously close to the panic levels of last December and January.

And Kazakhstan freaked out and devalued the tenge by 4.5% today, to 197.3 per dollar, the biggest drop since that infamous day in February 2014 when the central bank let the tenge plunge 20%. So today’s move is likely just a foretaste of what is still to come.

The Turkish lira dropped 1.3% today to a new record low of 2.93 per dollar, now down 4% since the yuan devaluation, and 8% for the past month. Political turmoil in Turkey and its proximity to a war zone are adding totally unneeded spice to the already difficult fundamentals in its economy and in the broader emerging market.

Vietnam lowered the reference rate by 1% today and widened the reference band to 3% on either side. In response, the dong fell 1.2%. After similar devaluations in January and May, the dong is down 4.4% against the dollar for the year.

Then there’s Japan. Shinzo Abe had announced in late 2012, just before he came to power, that his official policy would be to crush the yen, and that he would get the Bank of Japan to do it for him. He succeeded wonderfully. Since then, the yen has lost 36% against the dollar, annihilating over a third of the yen-denominated wealth of the Japanese.

The shenanigans of the Bank of Japan have driven the Koreans nuts. The two countries compete directly with each other in numerous areas. And last year, Korea lost its patience and retaliated. Now China has added fuel to the fire. The Korean won is down 2.9% against the dollar in 30 days and 15% over the past 12 months.

The Indian rupee which had swooned badly during the Taper Tantrum in 2013, but then recovered, has been re-swooning starting a year ago and is now back to the Taper Tantrum levels of 65.2 rupees to the dollar, having lost another 1.5% since the yuan devaluation.

The Taiwanese dollar dropped 1.2% since the yuan devaluation; the Malaysian ringgit 2.7%, now down 6.4% for the month and 15% for the year. The Indonesian rupiah lost 1.4% since the yuan devaluation and is down 11% so far this year. Other Asian countries, such as Azerbaijan and Georgia, have already devalued their currencies over the past year.

But devaluations are not free lunches. They’re desperate measures that demolish domestic consumption and real incomes (see Japan), business investment, and overall credibility. And capital flees. They can also heat up inflation. But many emerging market countries and their banks and corporations borrow in other currencies to get access to lower interest rates. That foreign-currency debt can’t be devalued or inflated away.

Instead, the opposite happens. Their struggling or battered economies have to service foreign-currency debt with their own devalued currencies. Commodity exporters are getting sapped additionally by plunging commodity prices. Then that foreign currency debt, that cheap easy money everyone got to used playing with, becomes an insurmountable pile of expensive debt in a currency they can’t control and whose exchange rate might run away from them.

This is when a debt crisis begins to spiral elegantly through the emerging markets, taking down banks, entire economies, and gobs of investors as it goes – or taxpayers in other countries if there is a bailout. It’s always the same story. But this time, it’s different: after years of global QE, low interest rates, and hot money sloshing through the system, the sums are larger, and the risks are higher.

The start of a tsunami? Read… LEAKED: GM Sees Overcapacity Fiasco in China, Hopes Americans Will Buy Lots of Chinese-Made Buicks

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  1. MyLessThanPrimeBeef

    Only one nation is exceptionally lucky with an import-driven/global reserve currency circulated model that’s free from this need to devalue or to service foreign currency loans.

      1. Whine Country

        Ouch! If the Communists hadn’t taken over we’d be talking about a shrinking Piaster, commonly referred to as P. When I arrived during Tet in 1968 we converted in the field at the rate of 1$ (MPC) for 1 P. IIRC the official rate was 5,000 P for 1$. Got to admit that falling P doesn’t sound anywhere near as worrisome as a shrinking Dong!

  2. susan the other

    Demolishing domestic consumption. Sounds like part of a plan. When everything floats it’s still a system being put to a purpose. Who says we don’t plan ahead? Everybody worries about the dollar losing reserve status. But the biggest devastation is to the EMs that banked on us. And all the rest of the free-riders. The dollar is already pre-disastered. It began in the 80s with the closing of our auto industries, sending them to Asia, followed by the rest of our manufacturing and jobs. We got nuthin left to lose. We haven’t “devalued” but we have suffered a big economic devastation. Now the EMs will have to reduce their own economies. I can’t help but believe there is method to all this madness which comes from a dedication to save the planet. It is just too orchestrated not to be.

    1. Massinissa

      You think the worlds oligarchs and governments are all working together for a sustainable future?


    2. Jonf

      Our currency gets stronger as they devalue making their goods and services less expensive. But they could suffer an inflation.

      1. Mike Sparrow

        pffft,. what devalued currency? Again, you aren’t answering the question. Currencies are overrated and always have been.

  3. Disturbed Voter

    When it comes down to it … all that matters is the Chinese politician and Chinese consumer vs the Thai politician and Thai consumer … for example. It is not possible to have everyone be a net exporter. Those that are have their advantages/disadvantages. In the end, it is just like 1930 all over again … over capacity chasing insufficient consumer demand. Now that China is moving to robotic factories … all labor other than management becomes surplus.

    1. MyLessThanPrimeBeef

      The peace-loving-Swiss-equivalent of neutrality in this round of Currency World War can include, I guess, Greece, who may want to join the Currency War, but is being forced to stay out of the violent conflict.

      “There will be atrocities on all sides of any Currency World War.”

      Who knows, whole national currencies may be wiped off the map.

      1. Disturbed Voter

        There will be plenty of unemployed youth to recruit into a shooting war. Even as mercenaries … as the Greeks did of old (March Upcountry by Xenophon). And Greeks will probably fight on both sides like the Irish did during the US Civil War.

  4. washunate

    But this time, it’s different: after years of global QE, low interest rates, and hot money sloshing through the system, the sums are larger, and the risks are higher.

    It is difficult to identify the point of that particular assessment. Is QE and hot money good, or not? Is ZIRP good, or not? Is the currency peg China has to the US dollar good, or not? Is Japan running large budget deficits good, or not? Is the hostility toward Russia good, or not?

    If the answer to those questions is not good, then that calls into question the whole paradigm of USFG money printing, from tax cuts for the wealthy to protection of financial fraudsters to backstopping of large financial institutions to guaranteeing of mortgages (and car loans and student loans) to Fed ownership of mortgage-backed and treasury securities to a historically low Fed funds rate to broader items like corporate trade pacts, IP law, media consolidation, and the national security state. But curtailing these things would constitute “austerity” – shrinking the aggregate flow of currency units from the federal government to the private sector.

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