China woes behind ASX meltdown

Posted on 22/06/2019 by

A stronger-than-expected Chinese currency devaluation is weighing on the benchmark ASX 200 index. Photo: Tyrone Siu The yuan has been gradually losing value against the Greenback.

The n sharemarket is in the midst of its worst start to a year in decades (it sank to a two-and-a-half-year low on Monday morning). The n dollar has fallen below the key US70¢ mark.

And it all comes just hours after Sean Penn’s weird interview with a powerful Mexican drug kingpin landed on the internet. Coincidence? Of course it is.

In all seriousness, Monday’s market meltdown has nothing to do with drug trafficking or Hollywood. But it is, at least tangentially, related to Mexico (more on that later) and has everything to do with China. 

Investors are fearful that things are even worse in the world’s second-largest economy than authorities there are portraying them to be. And that nothing can really be done to stop it.

Perhaps the best illustration of these concerns is found in China’s tightly controlled currency, the yuan. This chart shows how China has been allowing the US dollar to strengthen against the yuan for a while as its economy slows.

In other words, the yuan has been sliding in value, and that slide accelerated noticeably last week. That came as Chinese authorities tried, in vain, to stem another alarming slide in the Chinese sharemarket.

On Monday, the People’s Bank of China let the yuan strengthen, providing a temporary lift for stocks and the n dollar. But people are still fearful that recent yuan weakness could be a harbinger of a serious devaluation of the currency. And that could have considerable knock-on effects.

China, of course, is ‘s biggest trading partner. Problems there are not good news for this country in any way. Yet the latest episode of yuan weakness could be a much deeper issue.

The real worry about a weaker yuan, analysts from Societe Generale wrote on Monday, “is both that things in China get even worse and that a domino of defaults will engulf commodities and [emerging markets], ultimately contaminating the full credit universe”.

In other words, a sharply weaker yuan could  prompt investors in the US and elsewhere to pull money out of other emerging markets, like Mexico, and commodity exporting countries, like , leading to sharp declines for those currencies and risking defaults for the many companies in those countries with debt in US dollars.

We have seen that movie before. It’s called a full-blown emerging-market currency crisis. No one wants to see it again.

Fortunately, there is a long way to go before we get there again. And while China is not in a good place now, the world’s biggest economy, the US, is showing more signs of strength after posting a solid jobs report last week.

Time to get some popcorn, because there are more twists in this story to come.

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