Why China's Yuan Currency Is Being Manipulated by the Government

In an effort to boost exports and spur growth, China's government continues to manipulate its yuan currency.

For the second consecutive day, China's central bank cut the guiding rate for the yuan, its national and tightly controlled currency.

The People's Bank of China (PBOC) devalued its yuan by another 1.6% on Wednesday. That followed a record 1.9% devaluation on Tuesday.

Today, the PBOC fixed the "official midpoint" for the yuan down to 1.6% against the dollar. The midpoint is a guiding rate from which the yuan can rise or fall during the day. The daily trading band is set at 2% for the yuan currency.

Yuan (1)Until Tuesday, that rate had been determined solely by the PBOC. Now, the rate will be based on overnight global market developments and how the currency finished the previous trading day.

The central bank sought to reassure financial markets on Wednesday after the second yuan devaluation in as many days sent global stock markets lower.

"Looking at the international and domestic economic situation, currently there is no basis for a sustained depreciation trend for the yuan," it said in a statement.

But the PBOC has still made it clear it has a tight reign over the yuan currency.

The yuan can still be traded within a band, the PBOC still maintains its ability to manage the midpoint, and the PBOC will still intervene in the market to prevent excessive falls in the currency.

And with a nearly $3.7 trillion foreign-exchange reserve stash to influence its currency markets, China's central bank can ultimately do whatever it wants.

Here's why the manipulation of the yuan currency was necessary, in China's eyes...

Economic Slowdown Sparks Yuan Currency Manipulation

Wednesday's move from the PBOC came as China got more disappointing economic news.

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The statistics bureau reported industrial output in the Asian nation rose 6% in July. That was short of the expected 6.6% and down from 6.8% in June.

Meanwhile, fixed-asset investments rose 11.2% in the first seven months of 2015. That was the slowest pace since 2000.

Chinese exports also fell more than 8% last month. That fueled concerns the world's second-largest economy is heading for a sharp slowdown and will miss the country's FY2015 growth target of 7%.

There's no question China's economy has hit a rough patch. Growth has slowed to single digits after double digit rates just a few years ago. Plus, the country's stock market is well into bear-market territory.

But a currency devaluation is only a temporary fix.

Devaluation makes an economy instantly more competitive in the international markets. A weak currency cheapens a country's exports. That makes them more attractive to international buyers by undercutting competitors.

But it raises the risk of inflation. Additionally, as weaker currency pushes up import prices, it tends to spur higher wage demands.

Furthermore, it can cause a destabilizing "currency war."

Should other nations follow suit and devalue their currencies in retaliation, it could lead to competitive devaluation, or currency war. Talks of a currency war with rival nations have already started to surface amid China's currency manipulation.

Right now, the result of the recent yuan currency manipulation is a win for China. Here's a look at who stands to win and lose.

Winners of Yuan Currency Manipulation

  • Chinese exporters are poised to benefit. Textile and car companies, in particular, could become more competitive.
  • Foreign retailers will find Chinese consumer goods cheaper, as will companies using Chinese services, products, and components.
  • Foreign tourists to China will get marginal benefits from a cheaper (devalued) yuan.

Losers of Yuan Currency Manipulation

  • Chinese companies will have to pay more interest on debt in foreign currencies. Property companies and local government financing vehicles will be the hardest hit.
  • Chinese air carriers are also exposed to foreign currency debt and big fuel bills that have to be paid in dollars.
  • Exporters to China, particularly those in the luxury goods sector, will find it harder to sell their products as they become more expensive to Chinese consumers.

The real winner, however, just might be U.S. equity investors. China's yuan manipulation may prompt U.S. Federal Reserve policy makers to pause from raising interest rates for the first time since June 2006 next month.

While many investors are worried about China's stock market and its impact on U.S. markets, you don't have to panic.
Watch the video for an explanation of China's stock market crash, plus how investors can protect themselves – and even profit – from these events… 

Stay informed on what's going on in the markets by following us on Twitter @moneymorning.

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