It Starts: Broad Retaliation Against China in Currency War

Published on Wolf Street, by Wolf Richter, Aug 20, 2015.

The biggest global “tail risk” is China’s deteriorating economy and an emerging market debt crisis, according to BofA Merrill Lynch’s monthly poll of fund managers. And 48% of them were expecting the Fed to raise rates, despite languid growth and low inflation expectations.

Hot money is already fleeing emerging markets. Higher rates in the US will drain more capital out of countries that need it the most. It will pressure emerging market currencies and further increase the likelihood of a debt crisis in countries whose governments, banks, and corporations borrow in a currency other than their own.

This scenario would be bad enough for the emerging economies. But now China has devalued the yuan to stimulate its exports and thus its economy at the expense of others. And one thing has become clear on Wednesday: these struggling economies that compete with China are going to protect their exports against Chinese encroachment.

Hence a currency war … //

… Copper – Kazakhstan – Turkish lira – Vietnams’ dong – Japan – Indian rupee – Taiwanese dollar … //

… But devaluations are not free lunches. They’re desperate measures that demolish domestic consumption and real incomes (see Japan), business investment, and overall credibility. And capital flees. They can also heat up inflation. But many emerging market countries and their banks and corporations borrow in other currencies to get access to lower interest rates. That foreign-currency debt can’t be devalued or inflated away.

Instead, the opposite happens. Their struggling or battered economies have to service foreign-currency debt with their own devalued currencies. Commodity exporters are getting sapped additionally by plunging commodity prices. Then that foreign currency debt, that cheap easy money everyone got to used playing with, becomes an insurmountable pile of expensive debt in a currency they can’t control and whose exchange rate might run away from them.

This is when a debt crisis begins to spiral elegantly through the emerging markets, taking down banks, entire economies, and gobs of investors as it goes – or taxpayers in other countries if there is a bailout. It’s always the same story. But this time, it’s different: after years of global QE, low interest rates, and hot money sloshing through the system, the sums are larger, and the risks are higher.

The start of a tsunami? Read LEAKED: GM Sees Overcapacity Fiasco in China, Hopes Americans Will Buy Lots of Chinese-Made Buicks.

(full text).


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