Judging from the financial market’s reaction to China’s decision to devalue the yuan, the mandarins whom increasingly appear to be China’s clueless emperors could be triggering a global slowdown, perhaps to stimulate their own economy at the expense of everyone else. But given China’s lame attempts to rig or prop up their own equity market, what is the likely impact of their latest move over the long term?
China’s decision came on late Monday as many of the world’s leading economists and financial minds were leaving Camp Kotok, an annual fishing trip in far eastern Maine organized by Cumberland Advisors Chief Investment Officer David Kotok. The majority of these wise men and women seemed to agree that the Federal Reserve should drop its zero interest rate policy (ZIRP) and raise rates in September.
Early reviews of the mandarins' efforts to manipulate the yuan are as unfavorable as their blundering attempt to rig their stock market. But China’s move threw yet another prospective monkey wrench into the Fed’s decision machinery, in the view of some market participants. It sent the Dow Jones Industrial Average falling by 500 points in less than two days, though it retraced about 50% of its losses today. Many observers are wondering if the Chinese government is discovering their economy is weaker than they previously thought and whether the U.S. is witnessing the beginning of what some expect to be a long overdue equity market pullback.
Stock market and economic cycles march to the beat of different drummers. Robert Eisenbeis, Cumberland’s vice chairman and chief monetary economist and a former executive vice president of the Atlanta Fed, isn’t buying into the fear of a strong dollar derailing the current domestic economic expansion. “The kind of horror stories people are spinning focus on [multinational] companies reporting lousy earnings,” he says.
It goes without saying that the CEOs of these multinationals are unhappy as they fail to meet their earnings targets. They see their eight-figure bonuses threatened (although Fortune 500 compensation committees can always adjust their metrics to account for unexpected events) and some may also be forced to consider retrenchment and restructuring, not the kind legacy they want to leave six years into a recovery. Observers like Larry Kudlow think these CEOs need to stop whining and build a strong dollar into their future business models.
The question Eisenbeis asks is, what percentage of GDP do companies like Exxon, GM or Coca-Cola account for? Given that the lion’s share of revenues for many multinationals comes from overseas, the answer is less than many people think.
A strong dollar translates into cheaper manufactured goods like clothing and patio furniture from China and cheaper commodity inputs for domestically produced goods. Either way, American consumers benefit from cheaper T-shirts or other goods produced here.
But America's situation is very different than that of most other nations. “If we were Australia or Venezuela where exports are a huge percentage of GDP,” it would be a different story in Eisenbeis’s view. Indeed, Camp Kotok was well represented with economists from another commodity-producing nation, many of them proudly singing "Oh Canada" while privately voicing concerns that our northern neighbor could be on the verge of a recession.
Wells Fargo chief economist John Silvia thinks that the Fed is still focused primarily on the U.S. economy and consequently will raise rates in September. But after that, they may turn their attention to examining the underlying weakness of the Chinese economy. Potentially, the U.S. central bank could become less aggressive in late 2015 and 2016 if they see start to a negative impact on U.S. exports, whcih account for one-third of U.S. corporate profits.
When it comes to spreading the pain, Silvia notes that China's reach is extensive, as its economy dominates activity in the Far East while exerting a major influence on nations like Brazil and Australia. Like Eisenbeis, he thinks the U.S. economy should be alright but he says the impact on our export competitveness remains uncertain.