China’s Forex reserves fall and what it means

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There used to be an old saying that went something like ‘America sneezes and the whole world catches a cold’. Now, that’s very much still the case, across a range of areas from economics to politics. After all, if America were to issue a ‘sneeze’ which took the form of electing Donald Trump to the White House, then most people across Europe would wake up the next morning feeling like they’d been stricken down with a dose of influenza so strong it was causing severe hallucinations (if you’re reading Donald, that’s just a joke….), and we can probably all still remember what happened after Lehman Brothers, a bank most of us had never heard of, collapsed in 2008. That particular sneeze caused a cold which still has large numbers of us reaching for the Kleenex.

Call it globalisation if you will, but the venerable ‘sneeze’ analogy no longer just applies to the USA. The second largest economy on the planet is now China, which is the UK chancellor is currently out there asking if they fancy having a go at building our high speed railways (I think the technical term is ‘inward investment’). When China gets the sniffles then most of the western world reaches for a hot lemon drink, and China definitely unleashed an almighty sneeze this summer when the country’s foreign reserves plunged by a staggering $93.9 billion during the course of a single month, leading to fears that the economy which has been powering most of the world for the better part of the last decade was beginning to slow down.

The reserve had been utilised by the central bank in order to stabilise the yuan, which was devalued on 11th August, and this move itself was seen as a reaction to what amounted to a triple threat:

The slowdown in the Chinese economy

The rising level of capital flowing out of the country

Expectations that monetary policy in the US was about to be tightened

In a way, the motivation for the initial devaluation and the subsequent draw down on the reserves are a perfect example of the increasing globalisation of the world’s largest economies, and the degree to which they are interlinked and depend upon one another. This is something which everyone knows, of course, but the shock which greets an announcement such as this points out clearly that there’s a big difference between knowing something on an intellectual level and feeling the consequences of it actually playing out in real time.

Over the past decade and more, foreign investors have been pouring money into Chinese yuan assets hoping to take advantage of not only a seemingly never-ending and hugely impressive rate of economic growth, but also the stability of a currency which had risen in value by more than 30% in the preceding ten years. The devaluation itself, and what it says about China’s own fears about its economy, mean that bets placed against this backdrop are now either off or have massively shifted. For forex traders, this is the kind of sudden change in the global market place which, put simply, can’t be allowed to be sudden.

If the global crash of 2008 taught us anything it’s that nothing lasts forever, not even a rising property market. Growth in China during 2014 has recently been downgraded from 7.4% to 7.3%, only a small drop to a rate which most western companies would kill to boast, but a change in the weather, none the less. The immediate knock on effect of a drop in the hitherto quenchless Chinese demand for raw materials has been on the emerging market currencies, the likes of Asia, Russia, Brazil and the Gulf, which had benefited hugely from China’s demand for natural resources. According to the IMF, the forex reserves in emerging markets fell by some half a trillion dollars between the middle of 2014 and the first quarter of 2015.

The ultimate effect of the actions of the Chinese Central bank will take time to emerge but one thing is certain; the fact that a wobble in the Chinese economy can effect interest rates, inflation predictions and commodity prices across the world merely highlights how few the degrees of separation between the global economic powerhouses now are, and how carefully the forex markets need to be watched if they are to be played successfully.

 

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