China’s 1.9% devaluation of its yuan Tuesday roiled markets around the world.
There is a lot to digest. Chinese exports are going to become cheaper for those doing the buying, and the goods of nations selling to China will become more expensive to Chinese consumers. Since oil is priced in dollars, it becomes more expensive for China to import. But the Chinese government believes a cheaper currency will stimulate the domestic economy and offset the higher price of imports.
A weaker yuan also throws a monkey wrench into the plans of the Fed to raise interest rates. Higher U.S. short-term rates would increase demand for dollars — which is already high because foreigners are snapping up Treasury securities in a flight to safety as a result of falling commodity prices. The strong dollar has already hurt the performance of U.S. multinationals, many of which earn as much as half of their profits overseas, and makes U.S. exports more expensive. All that puts a damper on the U.S. economy, so a hike in interest rates would be just what the doctor WOULDN’T order.
The macro impact of the yuan devaluation, therefore, is likely to be a continuation of low interest rates in the U.S. and a slowdown in corporate earnings.
The micro picture is likely to see a battering of stocks with large exposure to China. Most of those companies are concentrated in the information technology sector, with the notable exceptions of YUM! Brands (YUM ) and Wynn Resorts Limited (WYNN ).
On Tuesday, YUM, which operates more than 6,800 KFC, Pizza Hut and Taco Bell restaurants in China, and generates more than half its corporate revenue there, saw its shares fall by more than 5%. Wynn, which yields 2% and gets 70% of its revenue from China, saw its stock slip by about 4.5%.
Telecom QUALCOMM Inc. (QCOM ), which yields 3.1% and derives 61% of its revenue from China, fared better. Its shares fell by just about 1%.
For me, being the gloomster that I am, China’s devaluation is reminiscent of the beggar-thy-neighbor tariff moves of the early 1930s that deepened the Depression. Countries, including the United States, which raised taxes on 20,000 imports through the Smoot-Hawley Tariff of 1930, thought that making imports more expensive would encourage domestic production. Not so. The higher taxes merely served to choke off trade, which only made the slump worse.
Today, we think of ourselves as more enlightened. Certainly our policy solons have seen the light and realize that freer trade benefits everyone. But devaluations and currency manipulation are another matter.
Politics as much as economics are part of the mix that help shape interest rates and currency values. And just as the politicians in the 1930s — however misguided — were trying to find a way out of the Depression by raising taxes, today’s politicians are trying to use currencies as a tool to gain an edge in a competitive world.
The Bottom Line
Whether it’s Greece and the euro or China and the yuan, it looks like currencies will be a battleground as long as the world’s economies remain sluggish.
Image courtesy of Keattikorn at FreeDigitalPhotos.net