So many of the movements that we see in the markets that we regard as unusual or unexpected are just plain economics. Movements create winners and losers and the danger – or the opportunity for investors – is when governments try to manipulate markets too much against these natural movements.
The yuan, for example, needs to depreciate. Chinese exports are down, economic growth is sluggish and, judging from Premier Li Keqiang’s speech on Saturday, the economy is in poor shape. This is an ideal recipe for a weak currency. Economics would dictate that the currency depreciates, maybe by a lot, making exports cheaper in more successful countries like the US (at the moment); thereby kick-starting recovery. The whole process is a natural outcome of free-market economics.
However, in any economic transition (as we have seen in the recent oil price collapse), the losers get hit almost immediately, and scream loudest. Depending on how influential the losers are, they will use whatever tools they have to prevent the adjustment. Too often natural economic processes that need to take place, do not, to the severe long term detriment of the economy.
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For instance, the UK virtually bankrupted itself in the 1960s by attempting to keep a coal-based, highly unionised, expensive and debt-ridden manufacturing economy afloat against competition from other countries that had greater competitive advantages in terms of cheap resources, capital and labour.
Transition threatens that status quo and the careers of politician’s that are tied up in full employment and provision of services to the public. It is tempting to use the economic tools at our disposal to ameliorate the impact of transition by “cutting off the bottom of the curve”. Too often, however, policymakers think they can hold back the tides of major economic forces, like a modern-day King Canute.
On the other hand, the winners in any transition tend to benefit over a longer period of time so they tend to be less vociferous. The winners are usually the weaker party for if they were stronger, the transitional process would be very quick.
Failed economic policies do not use or adjust the natural movements of the economy. The Chinese currency is over-strong at present because the authorities wish to retain buying power. One of the reasons is because the yuan was recently accepted as a component of the Special Drawing Rights, the virtual currency used for accounting within the global monetary system. To depreciate soon after this would appear scheming. Sometimes, a weak currency is seen as a sign of national weakness or a dent to national pride. This, of course, has never worried the US, which has retained a strictly neutral currency policy.