Currency devaluations are like car wrecks. They’re usually sudden and bloody, they hurt a lot of other people, and they create a mess that can stop traffic for hours.
As we’ve written before, I think that at some point, China’s currency is going to be in a car wreck… that is, the value of the renminbi compared to other big currencies is going to decline.
Since August, China’s currency has fallen about 5 percent against the dollar. (Given all the headlines, you might think it’s been a lot more). Since the beginning of the year, it’s down just 0.4 percent.
But China’s currency is under pressure. The economy is slowing down, and a lot of money is flowing out of the country. China’s government hasn’t learned yet that no matter how big and powerful it is, markets always win. And the more Chinese officials claim that everything is just fine, the sooner the currency wreck will happen.
In the meantime, the government is more concerned with firing senior officials than fixing the real problems. For example, last week the head stock market regulator in China was fired, as punishment for being boss during the Chinese market’s collapse last year. Blaming government bureaucrats isn’t going to make the bigger problems go away.
China’s currency wreck probably isn’t going to happen this week or next week or next month, or maybe even anytime soon. It could be a slow process. And China has a lot of reasons to avoid a wreck, like the loss of face it would experience just months after being allowed to join the adults’ table of global currencies in November.
Every devaluation is unique (just like every car wreck is different). One that I remember well – which might be similar to China’s, or could be very different – is what happened in Russia in 1998.
Back then, I was working for a Russian investment bank. Oil prices had collapsed (similar to what’s happening now), and Russia was almost out of foreign reserves (which are assets in hard currencies that are held by a central bank). China has US$3.2 trillion in foreign reserves, so this isn’t a big problem. But its reserves are down about 20 percent in just the past year and a half.
So Russia’s currency, the ruble, fell from about 7 to the dollar, to 12 to the dollar within a few weeks in August 1998. As the currency collapsed, the country’s banking sector imploded. If you found an ATM with cash, you took as much cash out of it as you could – and you quickly told your friends so they could do the same. Crowds of unlucky bank depositors mobbed branches, demanding their money back… but that cash – which was worth a lot less already – was gone forever.
In the days immediately after the start of the devaluation, some stores didn’t re-price their goods. So, a bottle of imported wine that had cost 210 rubles, still cost 210 rubles. But the dollar equivalent of that bottle of wine fell from US$30 (at 7 rubles to the dollar) to US$17.50 at the new exchange rate. People lucky enough to be holding dollars or other hard currencies suddenly found a lot of bargains.
During sudden depreciations, demand for things like cars often jumps sharply. That’s because people want to use their quickly depreciating currency to buy something that will hold value better than paper bills. (This is why gold is a great thing to own if a devaluation hits). It’s better to buy something that you can use, and something that you might be able to sell later at a good price, than to watch the value of your rubles collapse.
A devaluation hurts normal people who use the currency. That’s especially true if an economy consumes a lot of imported goods – because those goods are a lot more expensive after a devaluation.
So in Moscow in 1998, the bottle of wine still cost US$30. But at the new exchange rate (once the store re-priced its goods, or received a new shipment), it would cost 420 rubles (US$30 times 12 rubles, the new exchange rate). The price of anything that’s imported, from baby food to cars to ties, rises. But the amount of money people earn in local currency stays pretty much the same.
Again… no one knows when, or how, China’s currency is going to fall. When it does, it will be a wreck. But there will be opportunities as well, as I’ll talk about tomorrow.