By Raul de Frutos
After its surprise devaluation last August, a number of daily fixes in the Chinese yuan's exchange rate have followed.
As its economy slows down, the country is trying everything it can to encourage growth, such as weakening its currency to make goods more attractive abroad, while accelerating import substitution at home. The proverbial kitchen sink has been thrown at the growth problem in China.
However, while China pursues its domestic goal, the country is also worsening the financial stability of other countries.
Yuan-dollar exchange rate one year out. Source: Yahoo Finance.
As we pointed out back in August, a weaker yuan is bearish for industrial metal prices. Here are four reasons why:
It Encourages Chinese Exports, Expanding a Global Glut of Cheap Imports
When the value of the yuan falls, metals produced in China become cheaper and more competitive in the global markets. This helps to prop up exports of metals, such as steel and aluminum products, potentially hurting prices around the globe.
It Worsens the Already-Slow Global Growth
A yuan devaluation steals growth from other countries, as it puts global companies that trade with China at a disadvantage. Those countries that have more foreign debt than China will feel the pain the most. Europe is particularly vulnerable to this devaluation and to China's demand slowdown. Europe's economic growth has been weak for years, while using exports to fill the gap. It's estimated that 10% of Europe's exports go to China. Those exports are being reduced as the yuan loses value.
It Makes Investors More Bearish on China
Investors and traders are seeing the depreciation of the yuan as a sign that China's economy is slowing more than expected. Investors see the devaluation as a desperate government's actions to spur the economy, throwing a further pall over the market's mood. A clear sign of this is the current stock market meltdown that the country is suffering. When investors are not optimistic about China's growth, they don't buy commodities. That translates into lower metal prices.
It Doesn't Reduce the Excess Supply
Another repercussion of a weaker yuan is that Chinese producers are less likely to cut production. Many metal producers in the country remain in business despite high debt levels and extended periods of loss-making operations.
China is helping these zombie companies to stay in business with loans and actions such as the devaluation of its own currency, prolonging very much needed shutdowns. This situation only worsens the outlook for metal prices, which will never come back up until the shutdowns actually happen.