In early August, the headlines were inundated with the news the Peoples Bank of China (PBOC) had decided to devalue their currency in relationship to the U.S. Dollar. Not only did they devalue their currency, but they actually devalued it against our dollar three times in the same week. This was the largest currency devaluation by China in over 20 years. Our markets in the States were quite rattled by the news, as it seemed to come from left field. The Dow Jones Industrial average* dropped 277 points the day after the announcement only to rally to close the day near the flat line. The U.S. Dollar also had a few very volatile days as it traded from .975 against the world basket of traded currencies to .960 a day later (roughly a 1.5% drop in the U.S. dollar in one day). There is much speculation regarding the reasons why China decided to take these drastic steps to weaken their currency, but looking deeper, it is most likely a combination of factors that persuaded the PBOC to make these moves.
China has been fixing their current Yuan (Chinese currency) valuation to the U.S. Dollar for decades, and has wanted their Yuan to be a part of the free-floating reserve currencies for years. Every five years, the International Monetary Fund meets to determine who will be able to continue their currency status and who will be allowed to join the group. China attempted in 2010 to join the ranks of the world’s most official currencies like the U.S. Dollar, the Euro, the British Pound, and the Japanese Yen. However, the IMF told them that they were not quite ready to have their currency traded freely like the rest of the big boys. Well, it is that time again and in October of 2015, it is anticipated that the Chinese will attempt to get their Yuan to become part of the globally traded currency exchange.
Many countries are actively trying to devalue their currencies to help their economies out of the hangover of the global financial crisis started back in 2008 and 2009. This is what we can aptly describe as a currency war – a global race to devalue currency to stimulate exports. You would think the recent devaluation of the Chinese Yuan would cause the dollar to go up in value; in fact, the dollar actually lost value during the week of the announcement. If China is devaluing because of their slowing economy, then the chances of Janet Yellen (Federal Reserve chairperson) trying to raise interest rates in the near term may be put on hold. The raising of interest rates is typically done to slow down an economy, fight off inflation, and strengthen a country’s currency. It would be very stifling to the U.S. economy for Yellen to raise rates in the midst of the slowdown for the rest of the world.
This currency war and race to devalue is at the beginning of what could become a very long-term game. As the rest of the world devalues their currencies, the U.S. Dollar could continue to see strength which would continue to put pressure on commodities such as oil, natural gas, gold and other precious metals. It is also my opinion that we will continue to see volatility in the upcoming months as markets try to work through the barrage of information that never seems to slow. Now is as good a time as ever to call your financial advisor and develop a strategy to help manage the risks of the current and ever-changing markets.
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