It was a significant psychological moment in April 2008 when China saw its currency strengthen past 7.0 to the U.S. dollar. Three decades of tremendous growth had brought the "sick man of Asia" back to robust health, and it no longer needed to rely on an artificially weak exchange rate to make its products sell.
In the decade since, China's economy has doubled, to US$13.3 trillion. By 2010, it replaced Japan as the world's second-largest economy.
Now, for the first time in more than a decade, the currency appears set to soon break back above the 7.0 mark. Its psychological significance is also important now: The trade war is taking its toll, and exports again need that extra edge to keep them flowing. "China is weak again" is the 7.0 signal.
Investors need to beware this currency effect, because China holdings -- unless currency-hedged -- are seeing almost double-digit erosion since early last year. But they also need to beware a growing "RMB bloc" of nations in Asia that see their currencies move in synchrony with the Chinese currency.
The renminbi's influence has risen, particularly since 2015, across many economies, whether emerging or developed, Standard & Poor's outlines in new research. China's weaker-than-expected start to the year translated into weakness in the region. First-quarter economic growth disappointed in both Australia and India, and central banks in both nations have now responded with dual interest-rate cuts of 25 basis points.
It's essentially too expensive. This is true literally, and in terms of what it means for policy for China to resist a weaker yuan, Standard & Poor's writes in its assessment of Asia Pacific economics for June 2019.
The yuan at 7.0 seems an inevitability as Chinese exports, tariff-slapped, lose their competitiveness. That short-term effect will be compounded over the longer term if the rate of technology transfer into China slows, causing economic hardship.
"The economic costs of tightly managing the currency are substantial especially when the fundamentals are changing," Shaun Roache, S&P Global Ratings' Asia-Pacific chief economist, states. "We think that the economics will trump the politics of the exchange rate and China will tolerate renminbi flexibility versus the U.S. dollar."
In other words: If U.S.-China tensions persist or worsen, 7.0 will happen. Other commentators are coming around to that thinking.
"We do not believe USDCNY 7.0 is a line in the sand," Mark Haefele, UBS Global Wealth Management's chief investment officer, wrote in a mid-month note. He believes slower growth and trade tension will push the yuan past that mark over the next three months, albeit not for long.
And aren't lines in the sand made in, well, sand? They move. One wave, and the line is gone.
Investors should anticipate policy easing in China, and elsewhere in Asia. That means we're back to a situation where cash or foreign-currency holdings in Asia routinely lose you money the longer you hold them. Any U.S.-based investor buying Asia-focused or specific funds needs to make sure the currency is hedged into U.S. dollars.
China can absorb the effect of tariffs with a weaker yuan. It may initiate a sudden, one-off depreciation to offset protectionism produced by other nations. If it then allows market-driven weakening, it should not be destabilizing, S&P believes.
As this is a result of fragmenting global trade and slower Asian growth, "it's not great news," S&P states. But gradual currency realignments produced by fundamentals and tolerated by central banks are healthy, help the region, and a more-volatile yuan ends up being "good for China and good for the world."
A tightly managed yuan that's kept artificially high and pegged to the U.S. dollar would likely be disastrous. It effectively forces huge credit stimulus from China if it wants to sustain growth, while struggling against this drag on net exports and investment. It ties the hands of policymakers when it comes to managing China's economy (supposed to be shifting to services, and knocking inefficient state-owned enterprises into shape). Capital controls on the currency would become increasingly elaborate but also porous. And eventually everyone would fear a huge destabilizing devaluation anyway, leading to a flood of capital out of China and threatening the financial system in Asia.
Yuan 7.0 is a significant, and by currency standards sudden, change. The trend since 2008 has been one of increasing yuan strength. The clamor from U.S. lawmakers to brand China as a "currency manipulator" died down. China was happy that its manufacturing sector was still doing well, and keen to withdraw state support from the sector.
In early 2014, the yuan came close to breaching below 6.0 to the U.S. dollar, reaching 6.04 to the buck in January that year. There was another spell of strength in January 2018, when it hovered around 6.28. That same month, President Donald Trump slapped import taxes of 20% to 50% on all foreign washing machines and 30% on solar-panel parts. China dominates U.S. imports of both. In March 2018, Trump started attacking China directly on trade, and the yuan started to tumble.
The effect of the tariffs imposed on China so far have likely knocked 0.5% to 1% off its economic growth, "forecast" by the central government to run at 6.0% to 6.5% this year. Beijing hits those targets.
So it will likely need currency help. Since the onset of the trade war in January 2018, the yuan is down 9.5% against the U.S. dollar. But that's driven by the numbers. If anything, S&P calculates from Beijing's foreign-currency reserves, Chinese policymakers have been "leaning against the wind" to prop up the yuan and hold back its weakening slide.
The broadening intricacies of the trade tussle have hit smartphone maker Huawei Technologies with full force. But they are producing knock-on effects all along the supply chains feeding to Huawei and competitors such as Apple (AAPL) .
Blocking technology transfer into China would perhaps restrict Chinese growth to 4% or less in the 2020s, S&P says. For China to then push through difficult industrial reforms at the same time, it would have to let its currency go.
And that would produce a response for all of Asia. The yuan is increasingly influential across the continent. S&P did some fascinating research by pegging Asian currencies against a random free-floating one, the Swedish krona. Then they checked out how much the RMB is connected to other Asia currencies instead of the U.S. dollar.
Before 2015, Asia was a "U.S. dollar bloc." Most currencies were either actively managed against the U.S. dollar, or mapped it anyway. But since 2015, the Indian rupee, Indonesian rupiah and Philippines' peso have all started moving much more in sync with China's currency. They're only "softly pegged" to the U.S. dollar if anything, and are strongly influenced by the RMB, too.
Those are heavily managed currencies. The Australian dollar and the Korean won, which are much more free-floating, have started significant sensitivity to moves in the yuan, too. Australia, thanks to its heavy commodity shipments to China, is seen as a proxy to Chinese investments. Korea has consumer-tech supply chains intricately woven with the mainland.
Most shocking of all, the Malaysian ringgit has ditched a solid peg to the U.S. dollar altogether, and now it seems to be softly pegged to the yuan. The impact of the RMB ramped up after the financial crisis in the West, and the impact of the U.S. dollar vanished.
So as the yuan goes, Asia goes. The 7.0 exchange level would be just the start, a random crossing point that signals long-term weakness in Asian currencies in general.
Apple is a holding in Jim Cramer's Action Alerts PLUS member club.