13/08/2015 - 13:31

China currency shift – pain and gain

13/08/2015 - 13:31

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Following its recent currency devaluation, a more competitive China should prove to be a good thing for Western Australia’s export industries, but there will be some pain in achieving that possible future benefit because no-one knows how other countries will react to the China surprise.

Following its recent currency devaluation, a more competitive China should prove to be a good thing for Western Australia’s export industries, but there will be some pain in achieving that possible future benefit because no-one knows how other countries will react to the China surprise.

Early signs after the devaluation of the yuan have been mixed, partly because it wasn’t expected but also because of the uncertain effect on the US, where that country’s central bank is poised to lift interest rates.

If the US pushes ahead with a September rate rise, the effect could be more significant than the Chinese devaluation because higher US rates will suck money back into that country, boosting its currency and lowering other currencies, such as the Australian dollar.

Looking for winners and losers in any war is always tricky, including a currency war, which is what we are watching.

Goldminers have been the first to benefit, because the uncertainty factor has lifted the gold price back over the $US1,100 an ounce mark. Local goldminers, led by Newcrest, have responded with price rises over the past two days of between 7 per cent and 10 per cent.

Why there have been such steep rises by gold stocks is the first of many interesting questions, because the gold price in Australian dollars has not moved up significantly thanks to one of the perverse effects of what’s happening in the currency market – the Australian dollar has barely moved.

On Monday the Reserve Bank was quoting an Australian dollar exchange rate of US73.97 cents. Earlier today the rate was US73.84 cents, a miniscule difference on Monday’s rate.

Iron ore, the commodity of particular importance to WA, has been another interesting winner from China’s currency shift, with the price of high-grade material (62 per cent iron) creeping up by US9 cents to a reasonable $US56.31 a tonne, and second-grade (58 per cent) doing better with a rise of $US1.58/t to $US51.32.

The iron ore rise could be traders placing early bets on the devaluation boosting China’s export industries.

For local iron ore miners, the higher $US price (and the steady $A) is a bonus, especially for hard-hit Atlas Iron, which needs $US50/t to break even.

Other commodities have been mixed. Oil is back below $US50 a barrel, copper has risen modestly, and nickel has crashed back to a multi-year low of $US4.73 a pound.

Fluctuating commodity prices are one reaction to the currency war, put they are only a small part of a much bigger story that will prove to be a major test for Australia, starting with that prospective US interest rate rise.

If the US pushes the rate-rise button, a currency judder far greater than what’s happened with China’s devaluation will rumble around the world, possibly delivering a heavy blow to the Australian currency, which will benefit miners and farmers.

The flipside of a sharp increase in the value of the $US is that commodity prices will take a knock because most are priced in the US currency – and that means reduced demand.

In reality, no-one really knows what comes next in what could be the start of a period of global currency and economic realignment (with potential profound political consequences). It is possible that the US will delay the rate rise while it waits to see the effect of China’s currency move.

Some early observations about the effects of a cheaper Chinese currency include reduced appetite for Australian real estate, though as most of that buying has been in Sydney, it might not be a bad thing.

There has also been speculation that China’s downgrade, which has been described as a ‘beggar thy neighbour’ move, will force neighbouring countries to make similar devaluations, with the net effect being that nothing changes.

Whatever happens next, it would be wise to assume that a lot has changed even if the effects will be slow to surface.

Reserve Bank deputy governor Philip Lowe warned as much in a speech last night at the University of Western Australia. In delivering the 54th Shann Memorial Lecture, Dr Lowe hinted at a possible “chain reaction” to the devaluation, with potentially widespread consequences.

On the positive side of the equation, he said that if the currency shift “supported growth in our largest trading partner, it’s probably good”.

But he cautioned that no-one outside China knew why the currency had been devalued and whether it might be a signal that the Chinese economy is weaker than is widely believed.

Whatever the explanation, a large-scale currency experiment is under way and could run for some time, as markets and economies adjust to the next step in the search for the ‘new normal’, which might include a US interest rate cut as soon as next month.

Hang on for the next instalment of the wild ride, which started with the 2008 GFC.

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