The Chinese devalued its currency the Yuan last night by the most amount ever, almost 2 percent. The People’s Bank of China stated that it was a one-off adjustment and was only intended to keep the Yuan in line with the markets. The Yuan had its biggest fall since 1994, bringing it to its lowest level against the dollar in three years.
The Yuan has been pegged to the U.S. dollar, which has given the currency a high valuation and making it less competitive to the weaker euro and yen.
Unfortunately, the Chinese economy did not have the same underlying strength as its currency. The government has been propping up its stock market to the tune of billions of Yuan a day for weeks. Then over the weekend trade data showed that exports in July sank more than 8 percent and were down nearly 1 percent for the beginning of 2015.
The move worries many market watchers that a currency war is now under way and the result will be a tsunami of deflation around the world. The ripples from the move are now playing out in the U.S. markets in several ways.
U.S. Treasury yields plunged following the surprise announcement. As yields drop, the prices of the treasuries rise. In order to weaken its currency, the Chinese are expected to become buyers of treasuries.
The U.S. dollar became much stronger as a result and crude oil has dropped again, erasing Monday’s gains. Stocks in the U.S. are expected to open lower as investors digest the news and the effects on companies.
Looking ahead, the corporate sector in China is the most leveraged in the world and with this devaluation; there is concern over these companies being able to continue borrowing. The result would be a crashing halt to China’s big growth story.
The move is also bringing into question what the Federal Reserve will do with regards to raising interest rates. Raising rates will drive the dollar’s value even higher, making it uncompetitive with other currencies in the world.