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China Isn’t Playing to Win, It’s Playing Not to Lose

China Yuan devaluation

In a Barron’s Op/Ed, Guggenheim Partners global chief investment officer, Scott Minerd describes the recent equity market correction as “ultimately healthy,” and believes that the recent selloff might be the worst we see for now. However he believes more weakness could materialize. Mr. Minerd states:

“However, longer term, neither fundamental nor technical data support that we have reached the levels of capitulation associated with the end of a market correction.”

China Yuan devaluation

He continues:

“While in the U.S. fundamentals remain supportive of continued economic growth, technical indicators point to lower prices in U.S. risk assets.”

Mr. Minerd assigns blame for the recent volatility to the currency markets:

“So what is causing all of this turbulence? The source is the massive misalignment of exchange rates, which finds its roots in quantitative easing. Case in point, consider Japan, which has weakened its currency by over 50% against the U.S. dollar, while China, Japan’s largest trading partner, has basically pegged the renminbi (RMB) to the dollar.”

QE si the culprit

I agree that QE is the ultimate culprit here. It has caused misalignment in currencies and it has tasked many foreign central banks with micro-managing their currencies, causing some to devalue currencies one week, only to defend them the next. Thus, many foreign central banks have abdicated monetary policy to the Fed. They hang on for dear life while praying the Fed won’t act in a way which is harmful to their economy with few tools with which to respond.

I would also like to comment on Mr. Minerd’s opinion that China “has basically pegged the renminbi (RMB) to the dollar.” I believe he is correct. Remember, when China loosened its currency peg, it controlled how much the peg loosened. When it became necessary to defend the yuan (renminbi), it did not hesitate to do so by selling U.S. Treasuries. China has reformed very little (if at all). Those who believe that China’s currency motives were, in any way, motivated by a desire to reform its economy away from a command model are either blinded by their captivation with the China story or are simply not very adept at understanding the ideology and desires of the Chinese government.

Playing not to lose

In my opinion, the goal of the Chinese government is to make the people as happy as possible while providing as few freedoms as possible, so as to keep a firm grip on the country without fear of civil unrest. Seems fairly obvious. It also seems obvious that China will probably generate far less consumption-related demand than its population of 1.4 billion people would appear capable. To use a sports analogy; China is playing not to lose.

About Thomas Byrne 

Thomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.

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Thomas Byrne serves ad the Director of Fixed Income for Wealth Strategies Management LLC. Thomas brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets. High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.