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Market Overview

Current Overview August 12, 2015

Author: John Hsu/Wednesday, August 12, 2015/

On August 11th the People’s Bank of China (PBOC) surprised the world in devaluing the Chinese currency, the renminbi, by 1.9%. In addition, the central bank also announced a partial liberalization of its exchange rate mechanism. Purportedly this is a one-off action and at this juncture we have no reason to doubt the PBOC’s intentions.

It is perhaps relevant to review the recent exchange rate history of the Chinese currency. From mid-2005 to the middle of last year, the renminbi has risen by roughly one-third. This appreciation was only halted between the middle of 2008 to the middle of 2010 by China in the context of a stimulus program to protect China’s economy from the spillover of the global recession post Lehman Brothers. Nevertheless, the direction of the Chinese currency over the last 10 years has been in a singular upward direction. As a result, the renminbi has gone from being considered a grossly undervalued currency to being fairly valued.

During this period in late 2012, Prime Minister Abe came to power in Japan and began a multiprong strategy to revive the Japanese economy. Japan obviously is a major global exporting economy and as such rivals China on many fronts. One of Abe’s key strategies has been to implement a QE program with massive monthly bond purchases thereby deliberately devaluing the Japanese currency, the yen. Between December 2012 and currently, the exchange rate for the yen versus the dollar has declined 49%, from ¥87/$ to the current ¥124.

To us, this has the makings of a budding global currency war. Perhaps it all started in the US by Chairman Bernanke with a zero interest rate policy in late 2008 followed by Japan and the EU with their own bond purchasing programs. It has finally manifested itself in Beijing with a devaluation.

All are attempting to keep the deflationary forces at bay while struggling to revive their economies.

We understand that China’s slowdown and the recent devaluation have been accompanied by massive foreign currency outflows. This is only natural. The difference is that China is the only country with the deep pockets to withstand such an onslaught. With a near $4 trillion reserve, China can withstand the outflow because during the same period beginning mid-2005, its foreign currency reserves grew from $1.8 trillion to the current level.

We believe that the recent devaluation is part of a multi-prong strategy to stabilize and revive the Chinese economy. Implicitly, we expect to see additional fiscal and monetary stimuli during the remainder of 2015.

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