shutterstock_132616358After reading the different takes on the Chinese devaluation of the yuan over the last couple days, I have come to a different conclusion than most. I don’t think the Chinese are pushing a weaker yuan just to satisfy market pressure in that direction, as they have indicated. That excuse just seems a little too opportunistic.  I also don’t think the main Chinese agenda, at this point, is to have the yuan be included in the IMF’s Special Drawing Rights, although certainly they would like that to happen.  I believe the main concern right now in China is frankly, just survival of the regime.  They are looking out for number one.

The export driven growth model, that has been successful for China in the past, is no longer working.  Global growth is faltering in Europe, LATAM, and other emerging markets.  The United States is limping along as the oil shale revolution takes a breather.  Unlimited customer growth for cheap Chinese goods is no longer a reality.  The Chinese also have strong competition from other Asian countries that are now the low cost producers for the world.  China is facing pressure from both sides of the supply/demand spectrum.

In addition to export growth, China has relied on infrastructure stimulus to generate employment for its hundreds of millions of workers.  This tactic has also run its course.  Explosive municipal and corporate debt is limiting this economic model going forward.  Attempting to manage the economy from above, the communist authorities realize there is a debt bubble and have tried different tactics to deflate it, only to return to the same stimulus well once growth inevitably slows.  

The last option left to the regime was to fuel an equity rally where companies could lay off debt into the stock market.  This worked for a while but the music has stopped in recent weeks as Beijing realized markets can go both ways, even if you arrest the sellers.  The mirage of free Chinese markets has been exposed.  

Now the Chinese government is left with a slowing economy, millions of workers needing jobs, high debt levels, bridges to nowhere, and empty ghost cities.  So, true to form, they have retreated to the tried and true tactic of devaluing their currency to make their goods less expensive on the world market.  It’s not a path to a free floating currency but an act of simple desperation.  The Chinese authorities are also quite sure the Americans will do nothing about it and accept as much deflation as China wants to throw at them.  

This is why the yuan is being devalued.  The Chinese government is scared to death.  Because, at the end of the day, if the music stops, what happens to them?  What happens if China faces a real economic crisis and has no arrows left in its policy quiver?  Social unrest is a real possibility.  Or in those other dreaded two words that dare not be spoken, regime change.

I expect China to continue devaluing as long as necessary; it’s in their short term economic interest.  They have never been big on lofty Western ideals of free trade or open markets.  To the contrary, they only spout these ideals when it’s useful for them.  The Communist Party is attempting to muddle through this crisis until global growth returns, with tactics that have worked in the past.  
We will see if they are successful.  But I wouldn’t count on the yuan to be included in the SDR anytime soon.  And, the currency wars are just beginning.  I don’t think this will end well.

L. Todd Wood is a former emerging market debt trader with 18 years of Wall Street and international experience.  He is also an author of historical fiction thriller novels.  His first of several books, Currency, deals with the consequences of overwhelming sovereign debt.  He is a contributor to many media outlets and is a foreign correspondent for Newsmax TV.