China Devaluing the Yuan – Implications.

Markets are still reeling from the shock move by China to lower its currency peg to the USD by 1.9%.  That might not seem like much but in the context of the biggest deviation from the USD this year being just 0.16% it very much is and the markets certainly reacted that way.  Whilst China stated confidently it was a ‘one off’ few analysts appear to believe that.  Why?  Because China have now well and truly entered this ‘Currency War’ that has plagued the world’s central banks since the GFC – central banks trying to force down their currency through zero or near zero interest rates or rampant money printing to bolster exports.  For China too, it is most appealing as it kills 2 birds so to speak.  Firstly it addresses their global export competitiveness.  They’ve had to endure a 15% rise in value because of being linked to a USD rising on the much anticipated Fed tightening and at a time when China’s economy is showing serious wobbles.  Secondly it addresses the IMF’s main concern in not including them in the SDR last week, in that it is not yet an internationally freely traded currency.  This is a big step in that direction.  The danger?  Well they are near equal to Japan as the biggest holder of US debt in the world.  They have a large number of businesses heavily indebted in USD and have already seen some large defaults – this will just exacerbate that.

But why has gold shot up $25 since the announcement?  There are likely a number of reasons.  Firstly it is yet another very clear sign of a global economy in severe stress.  China is, on a like for like basis, the worlds largest economy and not far behind the US in a simple GDP account.  It is a clear sign they are in trouble.  Secondly, they are the world’s biggest consumer of gold (1,464 tonne YTD!!) and when you know your currency is going down one of the best means of protection is gold.  We’ve seen that very clearly in Australia this year where gold and silver are up 5% and 10% respectively in AUD whereas they are down 5% and 0.6% in USD terms – and that with the AUD at 73.9c today and most forecasts for high 60’s to 70 for year end!  

There is a line of thought that since the IMF rejected the Yuan for the SDR the gloves may be off.  This currency move could be the first, announcing their REAL gold reserves could be the next.  If you want a big jump in the gold price, should they do the latter, you just watch…