China’s Doing Yellen’s Job and Creating a Trillion Dollar Profit Pivot

Keith Fitz-Gerald Aug 12, 2015
27 

Despite what the markets seem to think and many news sources would have you believe, China’s move to devalue the yuan by 1.9% is not an act of desperation intended to prop up a failing economy. It’s not a surprise. And, it sure as heck is not the end of the financial universe as we know it.

Instead, it’s a brilliant move that singlehandedly changes the investing landscape and creates a fabulous new set of profits if you’ve got the guts and the smarts to make your move.

Today we’re going to talk about why and, more importantly, what makes the situation so very appealing and so potentially profitable at the same time.

As always, I’ve got a few specific recommendations to get you started.

Let’s begin by talking about what Beijing did and why I believe this is a major move that changes the investing landscape.

This is the biggest currency adjustment Beijing’s made in 20 years and it’s the biggest single drop since 1994 when China ended the old dual currency system.

On the surface, the 1.9% decrease in that nation’s central bank “reference rate” is designed to support exporters and boost market pricing in China. Western analysts view it as a threat because it’s clearly more “price fixing” on China’s behalf.

What they don’t understand is that China’s been propping up the yuan for years to guard against capital outflows, to protect foreign currency borrowers and to stabilize the yuan’s role in global trade as a potential reserve currency for the International Monetary Fund. If you think China’s got too much power now, imagine what the world would have looked like today if that nation had not restrained its currency.

Dropping the yuan is actually a means of making room for market-based pricing.

I’ve long counselled that Washington had better be careful what it wished for when it accused China of currency manipulation, specifically because of the kind of reaction that’s happening today.

Contrary to what Washington would have you believe about China’s currency being undervalued, the yuan’s real effective exchange rate has risen by 33% over the past four quarters, according to the Bank of International Settlements. In fact, the growth was so high and so fast that it was the single fastest appreciation move and the highest among 32 major global currencies tracked as reported by Bloomberg.

Dropping the yuan is not only logical, but part of the path China has to take to make its currency fully convertible.

In the old days, China would simply set a peg rate to the dollar that – love it or hate it – was completely arbitrary. Hence the currency manipulation allegations.

But now – effective immediately – market makers who submit prices to the People’s Bank of China as part of the reference rate have to take the prior day’s closing spot exchange rate into consideration, foreign exchange supply and demand, AND changes in major currency rates. In other words, market-based pricing.

This is exactly what’s required by the IMF for reserve status – that a currency be freely usable and market driven.

China’s Attack on the Greenback

The other thing that stands out about this move is that China is doing Yellen’s job. You’re not hearing about that… yet. But you will.

Classic economic theory dictates that a stronger dollar makes U.S. exports weaken, imports cheapen, devalues overseas profits, and brings about a sharp increase in domestic labor cost. By any measure, it’s a restrictive economic policy which is why the Fed has so far refused to raise rates and – with a straight face – been able to sell their zero interest rate policies for so long.

The problem is that sooner or later the markets always fix things themselves.

China’s move immediately makes the dollar stronger. That, in turn, further hamstrings U.S. exporters and worsens the trade imbalance with China. It also shifts the competitive advantage to Beijing.

Theoretically, Team Yellen would have addressed this by shifting the advantage to the United States with a rate increase long ago. Instead, what we got was more of the same – a totally inept sequence of fiscal blunders, stimulus and a “data-driven” Fed that’s scared of its own shadow.

China simply took matters into its own hands.

Washington and New York claim they didn’t see this coming and the headlines suggest it was out of the blue. Not true. In fact, China’s telegraphed this move for years.

For example, Yi Gang, a deputy governor at the People’s Bank of China noted on November 20, 2013, that “it’s no longer in China’s favor to accumulate foreign-exchange reserves.” Zhou Xiaochuan, who was the leader of China’s central bank at the time, proposed “supersovereign currency” that would diminish the importance of any national currency but especially the U.S. dollar in March 2008.

My point is that while Washington views the dollar as a weapon, China increasingly views it as a liability. And, in accordance with that nation’s view of the world, Beijing has simply taken steps to defend itself because our leaders couldn’t or wouldn’t.

So now what?

We’ve actually seen this playbook before, albeit in a different era with different actors. Think back to September 1931, when the United Kingdom stunned the world by eschewing the gold standard – and in the process, caused the pound sterling to plummet more than 30%.

The severe devaluation gave Britain an exporting advantage – until a “me too” effect led other major exporters to take a hatchet to their own currencies. Of course, there’s no gold standard to abandon today, which is a major reason the media have such a hard time envisioning another currency war, even as it happens right in front of them.

This time around, Beijing’s actions firmly shift the global economic balance in China’s favor. Sadly, Western Central Bankers and politicians could have prevented this situation, but that’s a story for another time.

What matters now is how you handle the situation and how to position your money for profits even as most investors will be left behind their own self-imposed “Great Wall.”

Three Plays to Make in the Opening Salvo of China’s Currency War

First, China’s move begs you to “buy” dollars.

The dollar has rallied against all major peers by 20% over the past 3 quarters according to the Bloomberg Dollar Spot Index and this adds fuel to the fire. That’s because the global growth story is all about the Fed, not trade. Remember, it’s the best looking horse in the proverbial glue factory; incidentally, I think China’s move just put Yellen’s rate hike on hold so the party continues.

The easiest way to play this is to buy the PowerShares DB U.S. Dollar Index Bullish Fund (UUP). It’s worth noting that if you already have U.S. based companies in your portfolio, you’ve got this base covered indirectly. So this ETF is really gravy or a complimentary trade to your core holdings.

Second, Apple Inc. (NasdaqGS:AAPL)’s suppliers just got a Christmas bonus.

Apple’s got hundreds of suppliers, but Hon Hai Precision Industry Co. Ltd (2317.TW) catches my attention. It’s part of the Foxconn Technology Group and has more than 1 million workers assembling iPhones, iPads, and other products including PCs, TVs, and gaming consoles.

You’ll have to do a little work to buy it, though, because it’s on the Taiwan exchange. Still, don’t let that deter you. The PE is a low 9.15, according to YahooFinance, and China’s yuan instantly provides a kick to margins that will be related to the upcoming holiday season. Most investors can’t think that far ahead, so they’ll be left far behind if I’m right.

Third, the commodity rebound will have to wait.

Oil, like many other commodities, is priced in dollars. That means it’s going to get cheaper as the dollar gets stronger, barring some sort of catastrophic supplier interruption. That’s important because global growth and global demand continue to increase. Many people are forgetting the linkage, which is why the best oil companies are now priced as if they’re going to go out of business.

One my favorites is a choice that we’ve talked about many times, the Williams Co. Inc. (NYSE:WMB). The dividend is a healthy 4.70% and it’s got billions in capital investment projects coming online, the value of which is not yet reflected in the stock price.

There’s going to be a lot of discussion in the days to come about what this move really means for markets. Most of it, sadly, will be tremendously uninformed and wrong. So don’t “buy” it.

Instead, concentrate on what you now know about the situation and why there are huge profits to be made.

Chinese bears have only been one thing consistently for 40 years… wrong.

Until next time,

Keith Fitz-Gerald

27 Responses to China’s Doing Yellen’s Job and Creating a Trillion Dollar Profit Pivot

  1. Alan Collin MD says:

    Hi Keith-We met in Italy in 2012 on the Oxford Club trip. Been following along with Money Morning. Any plans coming to Florida or doing something again with the Oxford Club?. Regards-Alan

  2. H. Craig Bradley says:

    Keith:

    To me, its really sad that America has lost its former leadership role on so many fronts over the years. We let other countries make “deals” advantageous to them and on their terms. China taking the initiative instead of the FED or Janet Yellen on interest rates or currency rates is just one recent example. A spike in stock market volatility was a direct response to China taking the lead and it being portrayed as a “surprise”. I suspect we have many more such “surprises” in our future coming too. Among them, learning to live with less at home and the actual true cost of debt eventually. Widespread realization that there is “No free lunch” will cause a riot.

    The recent agreement with Iran is another case in point. Iran gets what it wants ( $150 Billion unfrozen) but what do we get out of “The Deal” ? Very little, actually. So, Donald Trump is correct that the deals we do get are rotten for us but great (profitable) for nearly everyone else in the world. From immigration for Mexico to missiles and armaments for Iran, we lose- they win.

    I find it hard to imagine we can continue to maintain our standard of living or place in a changing world by blaming foreign countries for our own collective stupidity and incompetence. The next election changes little, judging by the issues being discussed and the (lack) interest in them evidenced by so many.

    • Jerry says:

      Craig, Trump wants to change these “rotten deals”. I like to see the glass half full as opposed to half empty. I like TRUMP – and I believe many of us are fully engaged, in spite of the present Administration & it’s numerous inadequacies!

  3. Glenn Garland says:

    I think it is interesting that China’s yuan devaluation comes on the heels of the IMF coming out with the statement that China was not ready to join the basket of currencies represented in the SDR’s. I believe that one of the stipulations advanced by the U.S. was that the yuan remain pegged to the dollar. I kind of see this as a slap in the face to the other nations. I wouldn’t be surprised if they have more gold than they are reporting, also. The future looks to be very interesting and volatile and if played right, very profitable.

  4. jim says:

    Will 80 year surplus in oil supplies still keep oil prices tumbling

  5. jim says:

    Oil is going lower

  6. Derek Blair says:

    As always, directly into the subject with your analysis, instead of endless introductory mindless chatter.

  7. Robert Hall says:

    Great article Keith. I appreciate your insight and critical eye.

  8. John Weaver says:

    I don’t understand why your recommend buying UUP?
    The NCO1 Game Plan of China appears to be starting is going to knock our economy to its knees, if I understand correctly.
    Why wouldn’t I buy Australian Dollars or Euros to protect my investments. I understand your Apple & WMB analysis.
    Thank you for your thoughts.
    r/
    John

    • Robert in Vancouver says:

      I agree John, it seems the US Dollar is closer to it’s top than it’s bottom, so UUP would seem to be the wrong thing to buy unless you are a day trader. There could be some upside to UUP over the coming days and weeks but it sure seems risky to buy so close to a top.

      I think the Australian and Canadian Dollars are much better buys at this time. They are both closer to their bottoms than their tops, and in the case of Canadian Dollar, it is backed by a country that has a balanced budget, shrinking national debt, and real private sector job growth in spite of low commodity prices.

      Since most pundits and analysts are telling us to buy US Dollars and sell AUS$ and CDN$, that’s a good indication you should do the opposite. When the almighty US Dollar drops in the near future, commodities will go up and the AUS$ and CDN$ will go up even more.

      • H. Craig Bradley says:

        Canadian currency is not backed by much more than ours. The Canadians sold most of their gold bullion since 2000. Very little is left in their vault(s).

  9. Jerry Perlmutter says:

    I think I understand what you are saying about the motives of the Chinese and the impact of the Chinese devaluation of the Yuan. I sure would like to hear more specifics of how I can defend my retirement (which makes me feel more vulnerable to these moves) starting now.

  10. Joe Mackey says:

    With the Hon Hai there are two ways available. One is the common stock on the grey market exchange (HAHAF), and the other a depository OTC (HAHPF). Which way are you recommending?
    Joe

  11. Steve Zee says:

    My biggest criticism of the FED is that they don’t explicitly state what it will take to make them raise rates. Why can’t they simply state that when unemployment reaches 5% and inflation reaches 3%, they will start to raise rates by 1/4 % every six months. Obviously they could chose different set of benchmarks, but at least this would make their strategy transparent, and make planning considerably easier for both businesses and individuals.

  12. Murf says:

    The US has been going gang busters devaluing the currency through quantative easing. Isn’t China saying its had enough and retaliating?

  13. ASHLEY GOODMAN says:

    I don’t really understand this. Why would China try to scuttle the dollar and the euro. They have so much of this stuff in their banks and reserves that it would seem foolhardy to try and destroy these currencies? I am sure that will use the strengthening dollar to buy assets worldwide. Are you advising that the Iranian treaty is a bad deal and should be scuttled as well? Then what happens to the US prestige and perhaps to its currency if the treaty fails. Maybe the future cannot be predicted outside the cycles. I think the world economy is not a crap shoot. What the Chinese government is to their stock market, the high speed traders and big banks are to ours. We don’t have a functioning government. Like Russia, we have oligarchs who control our destiny. Tell me are the oligarchs doing?

    • DC says:

      The US doesn’t have much prestige in the world any more. If the Iran agreement (not a treaty) holds up we will have even less credibility in the eyes of the world leaders by making another idiotic blunder.

      • richard kent says:

        Why not take you IRA,or any retirement and buy Gold or Silver with that money? Seems to me if the Gov’t does like it did during the depression, you would have dollars that’s no good.

  14. yngso says:

    The EDB – Eurasian Development Bank – has been established, but I bet the real fun starts when the Yuan becomes a reserve currency and alternative to the USD…

  15. H. Craig Bradley says:

    UNDERSTAND THIS

    Bill O’Reilly said last night on his Talking Points that America will never again sustain the necessary economic growth to provide security and prosperity unless Americans first stop being lazy and apathetic. I agree. Both political parties are about what’s in it for them, no us. Donald Trump is either a spoiler for the Republicans or a ringer for Hillary. Either way, nothing much will change. Just more talk and empty rhetoric in store for 2016.

  16. CHRISTOPHER BOWEN says:

    Thanks for your insights. China is a contradiction seeking resolution: Chinese CP mafia (some 85 million) seeking to ‘control’ 1.3 (-85MM) while aspiring to international status in currency, finance, etc. Add to which, the incredible environmental and economic challenges (no water, polluted rivers and streams, particulate air pollution on a major scale, defunct state industries and overinvestment in steel, housing, astronomic debt, etc.). Something has to give. Frankly I doubt anyone would choose RMB over $$$ until their economy is fully integrated and open to the international financial system. The CP mafia is cracking down on internal ‘threats’ while acting ‘liberalistically’ (new word:=seeming liberal) abroad. No one believes the latter so long as they do the former. The US has problems but compared to elsewhere we are still the best bet.

  17. Garret Foute says:

    Keith
    Thanks for your input and articles. Unless I missed it, I’d like you to comment more on the supposed effects of the devalued yuan and what happens in October if the IMF sees China’s actions, have now, put the yuan in the basket of currencies that my be represented in the SDRs .
    What effects that move would have on oil, import/export, and our dealings in other markets where the dollar is the main peg.

  18. P. Denver says:

    Thank you for your info. Looks like the FED misinterpreted a hole lot about what China was truly doing with devaluing the yuan. Yet as stated, the Chinese have talked quite directly (along with other countries) how fed up they are with the control and dominance the US has with the dollar.
    So where are this county’s Gifted Financial Leaders ??? It seems impossible that so much has been missed or passed over by the White House and the Feds. Where do we go from here??
    All the writings of doom and gloom correct or not??
    I do not believe many people have any idea of any big issues that may occur. MORE COMMUNICATION FROM ALL MEDIA may ultimately help. thanks

  19. P. Denver says:

    It is very sad that persons in responsible government missed the info the Chinese were giving “little by little”. It seems like a complex issue to me with outcomes unknown by the public.
    Lots of talk about a great depression etc. when in fact we still do not know exactly what will happen with the currency’s.
    The public in general does not have a clue of what is going on-hope all media will share what is known including TV News. Hope that Gifted Financial individuals will share thoughts and write some for the public .
    thank you for the article.

  20. RJ says:

    Some of the reader comments are most interesting (in spite of the often times lack of correct grammar and dropped words).

    With that said, this incisive article could, perhaps, help the reader if the author explained what he means by China “propping” up the Yuan. The knee-jerk reaction is printing money (sound familiar?), as in FED monetary policy. Moreover, author James Rickards had written that there is considerable “capital outflow” from China. But let’s not go there right now.

    It’s clear that China protected it’s export economy, anticipates IMF reserve currency, and, in fact, wants a market-based currency, as well as fired the opening salvo for a currency war.

    So what does George Soros think about that?

    In any event, so the USD strengthens relative to this move.

    But how long can we keep this shell game up?

    How long can we keep printing Treasuries that will never be paid off at face value?

    And how long before the other shoe drops: a complete loss of confidence in the dollar?

    Who would argue that this does not present new opportunities — if one is correctly positioned?

    That’s fine, certain classes of individuals will not be affected by deteriorating social, moral, monetary and economic catastrophes, as well as Mullah’s with nukes, however, there appears to be a perfect storm on the horizon, and when it hits, it’s not going to be pretty.

    • richard kent says:

      If people are smart, to me Trump should be the one for President. Clinton has broken to many laws that she should not be able to have a Government job. All the others are in it for the money and Trump says it like it is. That’s what I like.

  21. mswish says:

    I always read your articles and enjoy your insight Keith. Like anyone, [WE] are ALWAYS right, “Similarly to a broken clock twice a day! You KEEP writing, Ill keep checking the time, and if my public school math is correct, that should be a little less than 10 percent of the time! The other 90 percent, give or take, will be spent reading and deciphering the rhetoric my government has chosen not to censor! Happy Divesting, 🙂 P.S. Always save room for dessert, there may be none!

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