"If you are going to use probability to model a financial market, you had better use the right kind of probability. Real markets are wild. Their price fluctuations can be hair-raising -- far greater and more damaging than the mild variations of orthodox finance." -- Benoit Mandelbrot, The Misbehavior of Markets
Today's 1.9% devaluation of the Chinese Yuan against the U.S. dollar blindsided the entire world and had a tremendous negative impact on both commodities and equity prices on Tuesday. The short-term uptrend in grains and oilseeds may have come to an end, and around the globe, number crunchers will be trying to forecast the impacts from such a move. The world may be quickly divided into two camps -- those who will enjoy the benefit of cheaper imports from China's marketplace while others will be faced trying to export to this nation whose currency devaluation has led to reduced purchasing power.
This story may be far from over. While the country referred to this move as a one-time adjustment and the first of its kind seen in 20 years, a new market-driven scheme has been announced for the daily fixing of the Yuan against the U.S. dollar, based on the previous day's market close and a plus/minus-2% range.
There may be many reasons for such a move. To date, China has been unsuccessful in courting the International Monetary Fund to have its currency included in a basket of currencies which is viewed as a benchmark for global currencies. In order to meet the needs of the IMF, China must have a "freer floating and accessible currency," with Bloomberg reporting that the Chinese Yuan's share of world payments in December 2014 was 2.2%, as compared to 2.7% for the Japanese Yen, 7.9% for the British Pound, 28.3% for the Euro and 44.6% for the U.S. dollar.
China's other enormous problem remains its struggling economy and ongoing risks of deflation. Despite the country's weak economic data, which saw exports fall 8.3% in July from the previous year, its currency has been dragged higher by the trending U.S. dollar while compounding the country's issues, with the country said to be facing its weakest performance in 25 years.
The implications are many. Concerns exist that an outflow of capital from China could result in further upward pressure on the U.S. dollar, in turn weighing further on U.S. dollar denominated commodities as well as commodity currencies such as the Canadian dollar. Other reports suggest that the use of commodities as collateral for bank loans in China could result in commodities sold off as deals are unwound, further pressuring commodity markets. As well, overall import demand will be tempered as commodity prices move higher in Yuan terms.
Some headlines are already suggesting a potential race to the bottom with respect to currencies and a looming currency war as countries around the world struggle to defend their domestic economies. Only time will tell...
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