With the world’s eyes focused on the Brexit vote, and the subsequent rollercoaster ride of the stock market, we may be overlooking much more serious developments elsewhere. As recently as January world equity markets had a meltdown that was deep and sustained, triggered by weakness in the Chinese economy. China’s stock market collapsed in spectacular fashion, it was so bad that authorities had to limit trading to keep losses from being even more extreme.
Chinese markets eventually found a bottom and big financial media moved off to other headlines. But the slowing economy wasn’t the only challenge China had on its plate. When the economy started to slow down, investors started pulling money out of Chinese businesses and projects. When that happened, Chinese foreign reserves started to dwindle. Again the state intervened to limit outflows of foreign capital and, once again, mainstream financial media moved off to more compelling headlines. But the problem never really went away and now China is on the verge of an economic catastrophe.
Currency Meltdown
As China bleeds foreign capital that puts the yuan in danger of collapsing. The yuan is already at a nearly six year low against the dollar and there’s every indication that the Chinese government intends to stand aside and let it fall further. The percentage drop of the yuan is around four-point-seven percent.
Why It’s Important
The yuan losing nearly five percent is very convenient for China. A weaker currency means goods produced in China are less expensive than countries with stronger currencies. That is, in point of fact, how China managed to rob the U.S. and much of the world of its manufacturing capacity. In the old days the currency manipulation was blatant and deliberate. Today I’m sure the People’s Bank of China would claim that it’s merely a happy coincidence.
Reserve Currency
Another reason China’s currency meltdown is a concern is that the IMF added the yuan to its list of reserve currencies that can be used between countries to settle trade debts. Part of the reason China was extended that honor was because the IMF made them promise, in effect, that China would stop the silly currency games. Imagine if you’re an international trade bank holding the yuan as part of your foreign capital. You just lost nearly five percent for doing nothing other than holding that currency! Since trade banks deal in billions of dollars, that’s a big hit. The Brexit vote, which had the rest of the world looking the wrong way, seemed to make ideal cover for the Chinese to allow their currency to slide.
Chinese For Bank Bailout
All this woe has rolled up mainly on Chinese banks. Those are the banks loaning money to the businesses on the Chinese stock market. When those businesses crashed early this year, that meant they could no longer repay the money they owe Chinese banks, which have been hemorrhaging cash to cover the bad loans. At some point analysts expect the People’s Bank to step and bailout the largest banks. The technical term is “government funded recapitalization” which is a fancy way of saying “printing money” and dumping it to the banks. You don’t have to be much of an economist to understand that’s only going to make the situation with a weak yuan even worse.
The only thing keeping China afloat in the currency market right now is that the pound and euro got blasted by the Brexit vote making the yuan look good by comparison. But soon the Brexit vote will fade and China will, once again, be the weak link in the world economy. When the number two (or number three, depending on how you measure it) economy is sick, it’s going to take the whole world down with it.