For several years now, the yuan has hovered between a 6-1 and 7-1 ratio with the U.S. dollar. Basically, that means one U.S. dollar would buy you between 6 or 7 yuan. But now, the yuan “[has] slid as much as 1.9% to a record offshore low of 7.1087.”
7
That’s the biggest loss in a day since 2015.
1.9% may not sound like much, but for traders, bankers, and economists, it has major implications.
Q: Why does China want to weaken its own currency?
A:
It seems counterintuitive, doesn’t it? Why in the world would a country want to make its currency
weaker?
The answer is actually pretty simple. Imagine you were abroad on vacation, intent on buying souvenirs to take home. You would love it if the dollar was worth more than the local currency, because you could get more bang for your buck.
This is exactly why China has devalued its own currency – because a less valuable yuan essentially
negates
the effect of American tariffs.
Remember, a tariff is a tax on imported goods. So, now imagine this scenario:
Let’s say you run ACME Corporation. In order to make whatever it is you sell (like roadrunner traps, for instance), you import goods from China. But then your country imposes tariffs on Chinese goods. Suddenly, it’s a lot more expensive to buy what you need. To make up for it, you’d either have to cut your expenses elsewhere and charge customers more or stop buying goods from China.
But then China says, “Wait! We’ve devalued our currency! Now, just one of your dollars is worth over seven of ours, so you can buy
more
of our goods at a lower price!”
Suddenly, those tariffs are no longer such a barrier to buying Chinese goods – which means China no longer faces the prospect of losing your business.
Q: Why does this matter to the markets?
A:
There are several reasons, all based around one fear: that this trade war will get worse and worse and go on and on.
First, many investors fear this is a signal that the trade war could turn into a
currency
war. A currency war is when countries engage in a kind of
race to the bottom
, with each trying to devalue its currency against the other. When this happens, international trade can become a quagmire: Purchasing power can wither, consumers may pay higher
prices for even basic things like food, and inflation can rise. Of course, companies that depend on
exporting
their goods may also suffer. All these factors could end up creating a great deal of uncertainty – and by extension, volatility – in the markets.
For these reasons, currency wars are very, very rare.
The last time China devalued its currency was in 2015. The situation was much
different then, so we shouldn’t draw too many comparisons, but the ripple effects were significant. At the time, markets around the world all wobbled.
Another reason the markets don’t like this news? Concerns about additional retaliations from both sides with even
more
tariffs are in the offing. The markets tend to react negatively every time new tariffs are announced. Companies may pay more for goods, their profits may fall, services may be delayed, prices may go up, and business may go down. All
these
issues, of course, are generally reflected in their stock prices.
Q: So, what should we do about this?
A:
Take a breath.
For our part, one thing we
don’t
need to do is panic. Despite the recent turmoil, the markets are still near record highs. Even if the trade war leads to a full-blown market correction (a 10% decline in stocks from a recent high), that simply means we may have new investment opportunities in the future. The fact is, we’ve always known the trade war could last a long time. To date, the markets have weathered the storm. They may still do so now. But even if they don’t, we won’t be unprepared.
On the other hand, if these recent developments have told us anything, it’s that trade tensions aren’t going away anytime soon. My advice? Let’s prepare ourselves mentally for more negative headlines to come. (Often, mental preparation is the absolute
best
defense against making panicked decisions with your money.) Let’s also remember that, while there may be no end in sight to the trade war, it’s only a small portion of our total economy. And our economy as whole is still quite strong.
I hope this letter has given you some insights as to what’s going on in the markets right now. I find that the more we understand
why
things are the way they are, the less we need to fear them. My team and I will keep monitoring your portfolio closely. If at any point we feel a change in strategy is needed, we’ll let you know immediately.
As always, if you have
any
questions or concerns, please let me know! My job is to address them. In the meantime, thank you for the trust you place in me and my team. We’ll continue working hard to help
you
work toward your goals.
Have a great rest of your summer!
Sincerely,
David M. Gallagher
Wealth Manager
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Sources
