China’s Headache Could Go Global

What's going on here?

China’s “piggy bank” of foreign currency savings experienced another significant decline in December. This is part of the reason why you often hear people worrying about China’s effect on global markets.

What does this mean?

For the past few years, China has sought to have its currency, the yuan, gradually decline in value versus other major currencies (especially the US dollar) – partly in order to make it easier for Chinese companies to sell their goods abroad. The key word is “gradually”: it doesn’t want the yuan to fall sharply in value (which would probably be too de-stabilizing for its economy). To ensure the drop is gradual, it spends some of its savings of foreign currencies on buying its own currency in the open market to support the yuan’s price. Over the past 17 months, these savings have declined by $1 trillion (it has about $3 trillion left, which shows it’s an unsustainable strategy).

To help with its efforts, China has put new restrictions on the amount of money that people and businesses can take out of the country (because if less money leaves China, less yuan is sold and China doesn’t have to spend as much of its savings buying yuan to protect its value).

Why should I care?

For the markets: Chinese demand is very important to the global economy.
Imagine if it became much harder for American people and businesses to spend their money outside of America: it would result in a massive decrease in spending in other parts of the world. China is the world’s 2nd biggest economy, so any new restrictions on its people and businesses spending their money outside of China could have a big impact on the rest of the world.

The bigger picture: China (arguably) is becoming a notably more closed economy. (tweet this)
Last year, it became increasingly evident that many US firms are facing higher hurdles when operating in China. Now, despite supposedly making its currency more freely tradeable, China is doing the opposite of that.

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