By Michael Ashton
It is obviously time for another update. I haven’t been an active poster recently, because as many of you know I am busy working on a book for the Wiley label. I am about 80% done; however, it is very time-consuming! The title of the book is (tentatively) What’s Wrong with Money?: The Biggest Bubble of All – and How to Invest with it in Mind, and if you would like to be on the notification list to receive an email when the book is published, simply send an email to [email protected]. Even better, you can pre-order it already apparently, even though it’s not due out until later this year or early next year. (No pressure, huh?)
So, I have been embroiled in the writing and editing process, and not posting much. This will change soon, but China’s overnight move to (slightly) devalue the yuan is significant enough to warrant a post. There are also some other topics that need a quick mark-to-market, but I will save those for another day.
China’s move is possibly qualitatively significant, but I don’t believe it is yet quantitatively significant. A two-percent move in a currency is barely worth recording – it is almost within the daily standard deviation band of some currencies! So, when you have read about how this dramatically changes the inflationary concern of the Fed to a deflationary concern…that’s nonsense. The Swiss Franc strengthened by 20% against all currencies, in a single day, back in January. Since then, the core Swiss inflation rate has moved from +0.4% y/y to -0.6% y/y. Also note that Switzerland’s imports amount to about 50% of its GDP.
Let’s take that as a back-of-the-envelope scalar just to do a rationality check. A 20% change in exchange rate affecting about 50% of goods and services caused a 1% move in core CPI.
The U.S. imports about $40bln in goods from China per month, out of an annual GDP of $16.3 trillion. So in this case, we have a 2% move in exchange rate affecting about 2.9% of domestic goods and services. So if the effect was linear, we would expect about 1/10th * 1/17th * 1% of a move in core CPI as a result of the Chinese action. Check my math, but that would seem to be about 0.006% movement in expected core inflation as a result of China’s revaluation. Negligible, in other words.
Now, qualitatively the effect might be higher if, for example, this presages a more-significant move by China. But even assuming that the exchange rate moved ten times as much, you are still talking about rounding error on inflation. Sure, the effect might not be linear but the essential guess is that from a price perspective we don’t care.
Certain companies and industries and goods, of course, will see a much bigger effect (it would be hard to have a much smaller effect), but it shouldn’t be a big deal – even if it is part of a larger move. From the standpoint of economic growth, it may matter more…but even so, a 2% change is unlikely to matter as much as a 10% change in shipping costs, and moves like that happen all the time.
China is a big economy, and a big trading counterparty of ours. But the U.S. is still a significantly-closed economy. While China represents about 20% of all of our imports, imports as a whole only amount to 14% of US GDP. So, in summary: this is an interesting moment politically, if China is signaling a willingness to float her currency. It is not a particularly interesting day macro-economically, at least from the standpoint of the effect on prices of this move.