It looks as if George Soros is right about China’s currency—the yuan appears to be collapsing before our eyes. The yuan, which has lost five percent of its value since August, fell to a five-year low of .15¢ USD and .14 in Euros during the week of January 4.
To make matters worse, Bloomberg Intelligence Economics estimated that the yuan will need to be devalued by another 14% to stimulate China’s economy. Were that to happen, the yuan would drop to around .13¢ US and .13 Euros in value.
A drop in the yuan’s value is needed to boost China’s level of exports, which has been falling. The amount of Chinese exports fell by around 6.8% in November, according to Bloomberg. One reason for this is the strong U.S. dollar, which makes some Chinese products more expensive in China’s most important overseas market: the USA.
A drop in yuan value could be good for Chinese industry, but there is a big danger that Soros has noted. The danger is that capital will flow out of China as investors try to protect their assets from depreciation. This fear is very real and potentially highly destructive; China’s stock markets went crazy with losses of around seven percent and two trading freezes in the days after Soros made his yuan pronouncement.
This puts the People’s Bank of China between a rock and a hard place. It can depreciate the yuan and grow the economy, but that could cause panic that could lead to inflation and outflows of capital and credit that could stall economic growth.
Is Stagflation Coming to China?
One result of this could the dreaded stagflation, in which economic growth stalls out while prices keep rising. The People’s Bank is claiming this will not happen and that China’s economy will grow by around 6.9% this year while its consumer price index rises by around .1% from 1.7% to 1.8%.
Some observers cast doubt on this optimism; the Japanese investment bank Nomura estimated China’s economic growth rate for 2016 at 5.8%, or 1.1% lower than the official forecast. Nomura also estimated that China’s rate of imports will only increase by 2.3%, which is .8% lower than the People’s Bank estimate of 3.1%.
The wild card in this scenario is fixed asset investment in China, which the People’s Bank claims will be at a rate of 10.8% in 2016. That investment rate is heavily dependent on foreign money, which obviously stays away in times of currency collapse. The People’s Bank is also betting heavily on China’s retail sector, which it expects to grow by 11.1% in 2016.
The big danger here is what happens if the growth in fixed assets and retail does not occur. It sounds as if the People’s Bank expects China’s retail growth to make up for the drop in export growth. If that does not occur, the Bank could try to make up the difference by further depreciating the yuan, which could lead to even more panics and capital outflows.
There are some other strategies the Chinese could pursue, such as increased government spending, something that has not worked in Japan, or lower interest rates, which has had mixed results in the United States. Even if these policies were to work, they would take time, probably years; the currency markets operate on a day-to-day basis.
What Soros Is Betting On
That means there could be little or nothing the People’s Bank could do to prevent a sudden depreciation of the Yuan, which is what Mr. Soros seems to be betting on. He also seems to think that a great many Chinese, particularly businesses, have borrowed too much and could be under water if depreciation comes.
There is no guarantee this could occur, because of external factors such as the massive drops in commodities prices, particularly oil, in recent months. The fall in commodities prices could lower manufacturing costs and provide an economic boost similar to that from devaluation.
The danger is that commodities-dependent economies now have less money with which to buy Chinese goods, which cuts demand for exports and raw materials, further depressing commodities prices. This has created a vicious cycle that has already led to massive deflation and depression like conditions in countries like Venezuela.
The commodities freefall means that we probably will not see a repeat of the 2008 crisis, which was followed by a period of high oil prices. Instead, it looks more like a long-term economic slowdown.
Will It Affect the Yuan’s Reserve Status?
That means we will not see anything like the high rates of Chinese growth that have partially fueled the limited economic recovery in the United States for the foreseeable future. Instead, we will see limited growth accompanied by currency depreciation.
One result of this could be to push the International Monetary Fund to reconsider its decision to grant the yuan special drawing rights, which makes it a reserve currency. That’s supposed to take effect on October 16, 2016, but it may not happen if the currency experiences massive depreciation. Another result could be to throw the IMF into chaos.
A more interesting effect, which currency investors will take note of, would be to greatly increase the value of the U.S. dollar, which is, strangely enough, the most stable of the SDR currencies. One reason why dollars would gain value would be that Chinese investors might start buying up large numbers of them to offset losses in the yuan. Another might be to further drive up the value of the U.S. stock market as money that was flowing into China flows back into the U.S., particularly if America is seen as a safe haven in a world of economic chaos.
There are, of course, other factors here, such as the health of the U.S. economy, the highly unstable Euro, and the commodities collapse, all of which could make the situation worse and further depreciate the yuan. It looks as if Mr. Soros is absolutely right; the yuan is a highly unstable currency prone to collapse, and China is not the reliable engine of growth we’ve been led to believe.