China allowed the world to catch a breath on Friday, Jan. 8. Chinese stocks rose 2 percent and the central bank fixed the currency a tad higher. Global stocks are more or less unchanged.
After a week of complete market chaos, this is a welcome break, but it won’t change anything in the long term says James Rickards, author of “Currency Wars” and “The Death of Money.”
“The Chinese are communists and they don’t know anything about capital markets. Putting communists in charge of capital markets is like giving a loaded gun to a 3-year-old,” he told Canadian broadcaster CBC.
He says their biggest mistake was to shock the world by devaluing their currency last August. “You never shock the system; you always let people know what’s coming,” he said. At that time, the move came as a complete surprise and shook the world’s belief in Chinese central planning.
Since then, the Chinese authorities have learned their lesson—although a bit late—and are sending signals that the currency has further to drop.
According to Reuters, the central bank stated on its website on Jan. 8:
“The central bank also said it would make the yuan more international, keep the currency basically stable, further improve the currency formation mechanism, and deepen reforms of the foreign exchange management system and financial institutions.”
Translated, this means the yuan will depreciate further against the dollar. China has a restricted set of choices, according to the law of the impossible trinity:
1. Have an open capital account
2. Have independent monetary policy
3. Have a stable exchange rate
At any given time, only two are possible. Rickards says China will choose an independent monetary policy and an open capital account, similar to most developed markets. “They have to devalue the currency. They are not going to close the capital account, there is too much pressure from the International Monetary Fund. They are not going to give up independent monetary policy. They are not going to raise rates to stop the capital outflows, so they have to devalue the currency,” he said.
As for the transition to a consumer economy, Rickards thinks it will take longer than people expect.
“I am not so sure the demand is there. There are a lot of Chinese people, but their income distribution is widely skewed. They have a sort of middle class of 200 million people out of a population of 1.2 billion, but those people are practically eating bark off the trees, they are pretty poor,” he said.
“Those who do have some money, a lot of them sank the money into overvalued assets like real estate and stocks, so they are taking a beating. This transition to the consumer-driven economy, we are talking something that will play out over 5 or 10 years; it is not going to rescue the situation today. China’s growth has hit an air pocket—it is going to go down a lot.”
