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Why China's Latest Move Will Affect Your Bank Account

By Justin Brill
Saturday, August 15, 2015

The Weekend Edition is pulled from the daily Stansberry Digest. The Digest comes free with a subscription to any of our premium products.
 On Tuesday morning, China surprised the world by devaluing its currency – the "yuan," or "renminbi." The yuan fell by nearly 2% versus the U.S. dollar, making it the biggest one-day currency move since 1993.
China's central bank – the People's Bank of China ("PBOC") – described the move as a step toward a more "market-driven" exchange rate.
For some background... The PBOC sets a midpoint – known as the "daily fixing" – for the yuan against the U.S. dollar each day. The yuan is then allowed to trade 2% above or below that point.
In theory, the bank would set the midpoint based on how the yuan trades the previous day. But as an article in the Wall Street Journal explained, that has often not been the case...
The central bank sometimes ignores the daily moves, at times setting the fixing so that the yuan is stronger against the dollar a day after the market has indicated it should be weaker.
With Tuesday's move, the fixing will now be based on how the yuan closes in the previous trading session. As a result, the yuan's fixing was weakened by 1.9% Tuesday from the previous day, leaving it at 6.2298 to the U.S. dollar, compared with 6.1162 on Monday. The yuan dropped as much as 1.99% from its previous close to 6.3360 against the dollar in Shanghai and fell as much as 2.3% in Hong Kong in early trading.
The central bank said in a statement posted on its website that the yuan's midpoint has diverged quite a bit from the market rate for a relatively long time and that it was time to make the midpoint more market-based.

Many in the financial media took the PBOC's comments to mean the devaluation was a "one-time adjustment" and the government would be more "hands off" with the yuan. But that stance was already called into question just one day later.
 On Wednesday, the PBOC set the currency's daily midpoint at 6.3306, even weaker than Tuesday's devaluation. The yuan again fell nearly 2% to four-year lows versus the dollar, and is now down around 3% since Monday. While that might not sound like much, it's a huge move in such a short period of time for a major currency.
 Tuesday's devaluation set off fears across the financial media of a new round of currency wars – the trend of major governments competitively devaluing their currencies.
These "competitive devaluations" are ultimately a race to zero. But they do allow governments to pay off their massive debts more cheaply... or to temporarily boost their economies by making their exports cheaper to the rest of the world.
 There are also growing fears that China's once-booming economy is slowing down.
At the same time, the U.S. and other major economies have long been pressuring China to open up its markets and economy.
The timing of this week's devaluation suggests China could be using this pressure as cover to weaken its currency and attempt to boost its economy.
But there could be another reason behind the move...
In short, he believes China is determined to have the yuan added to the International Monetary Fund's ("IMF") list of global reserve currencies.
Adding the yuan to this basket would bring China new global status... and could potentially send trillions of dollars into China's economy.
While all signs suggest China's currency could be added to the list as early as this year – IMF managing director Christine Lagarde has said it's a "matter of when, not if" – some hurdles remain.
The IMF updated its stance in a report last week. From an article in the Financial Times (emphasis added)...
A judgment about whether the renminbi is "freely usable" is crucial to the IMF's final decision. As part of the review process, the board recently held an "informal meeting" to discuss the staff report.
"Across a range of indicators, the renminbi is now exhibiting a significant degree of international use and trading. At the same time, the four freely usable currencies (already in the [basket]) generally rank ahead of the renminbi," the IMF staff said in the report.
"The report signals that the decision about the renminbi's inclusion in the basket hinges on financial market development, further opening of the capital account, and greater exchange rate flexibility," said Eswar Prasad, former IMF country head for China.

In other words, the IMF wants the yuan to trade more freely. Tuesday's move could be a big first step toward that goal.
 This week's devaluation appears to be a "win-win" for China. It moves the yuan one step closer to reserve currency status, and could potentially boost China's economy.
But further declines in the yuan – especially large declines or an outright crash – could cause investors to flee the currency and put its IMF inclusion in jeopardy. This may explain the PBOC's late-day "intervention" to prop up the yuan.
So while we can't predict China's next moves, don't be surprised if this "balancing act" continues.
 If you're like most folks, you may be wondering what the devaluation could mean for you and your money.
So we checked in with Steve, who shared his thoughts on the situation in a private e-mail with us this week. As you'll see, Steve believes we need to keep this week's moves in perspective...
In the last 12 months, every major currency is down versus the dollar... except China's currency. It doesn't matter if it's emerging markets or developed markets. Take a look:
Russian ruble, down 36%
Brazilian real, down 27%
Australian dollar, down 19%
euro, down 17%
Chinese renminbi, up 0.3%
So China's currency has gotten incredibly expensive relative to other currencies in the last year. While I admit I didn't see the devaluation coming, I don't see it as that surprising, or as that big of a deal. It's a way for China to keep its exports competitive with its neighbors.
One positive here is that it is another step toward China "liberalizing" its currency... allowing it to trade more freely. This will get it closer to "approval" as a reserve currency, which is the Chinese government's goal.

In other words, China is allowing the yuan to play "catch-up" with the recent moves in other currencies. And the move is unlikely to have long-term effects outside China and its neighbors. He also thinks further large declines are unlikely...
The short-term risk – and I don't expect this – is that China will keep letting its currency weaken. My guess is that they will stop its fall soon, but I could be wrong. We have two China income funds in my True Wealth letter, and those would be hurt if China's currency kept weakening... so I will be watching this situation closely and I will report on it in my True Wealth letter next week.

 While Steve doesn't expect this week's move to have serious effects on investments here in the U.S., he thinks the yuan's eventual inclusion in the IMF's reserve currency basket will.
Steve says it could trigger one of the most profound transfers of wealth in our lifetime. It won't just affect China... It will affect every American, and anyone else who holds U.S. dollars.
It's so important, Steve recently sat down for an interview in Washington, D.C., to explain what's going on. If you haven't seen it, we urge you to take a few minutes to understand the details of a story most Americans have never heard. You can watch Steve's interview for free by clicking here.
Justin Brill

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