Ask DWM: What Does China Devaluing its Currency Mean to Us?

Barron's Chinese YuanGreat question. Thanks. China is a very big deal. Much bigger than Greece (see DWM blog 6/30/15). China is currently the world’s second largest economy, about 60% of America’s GDP. It is expected to surpass the U.S. in nominal terms in 11 years. And, by 2050, China is expected to have a population of 1.4 billion (vs. the U.S. at 400 million) and GDP 50% larger than the U.S. For the last 25 years, China’s economy has grown at a 10% annual rate. In 2015, the growth is expected to be 7%.

China devaluing its currency last week came as a big surprise to many. In our blog of July 29th, we featured an article about the Big Mac Index with the Economist’s report showing that, on an adjusted basis, the Chinese yuan was undervalued by 9%. Until last week, the Chinese government’s strategy has been to keep their currency within a narrow trading band against the dollar. And, then last week, the news came out of Beijing that the country will now link it more closely to market forces. There were two major reasons.

First, they are trying to keep their growth and employment high. As we discussed in that July 29th blog, the WSJ Dollar index has risen 22% in the last 12 months. Since last December, the dollar index was up 9% as was the Chinese currency, the renminbi, otherwise known as the yuan. This meant that the cost of Chinese goods for people in the Euro zone, Japan, or the UK was 9% more than it was at the beginning of the year. As a result, Chinese goods have become more expensive abroad, as American goods have. And, this is hurting the Chinese economy big-time in growth and employment. Exports dropped by 8% in July. Furthermore, China experienced a stock market crash in the last few months as well.

One of the key tools that countries use when they are experiencing a downturn is to devalue their currency. Typically, this is what allows countries to stay competitive in the market place by making it cheaper for their customers to buy their products. Being tied to the USD wasn’t working. So, last week, the Chinese government allowed the yuan to become more market driven and it declined in value by 2%. At this point, it is difficult to determine what the future value of the yuan will be. The 2% is not in itself a big deal, but it may lead to a 10% devaluation or more (Barron’s August 15th). However, the linking to market forces is a big deal and represents the second reason.

China’s government wants its currency to become globally pre-eminent. They want the renminbi to be recognized as a reserve currency, along with the USD, the euro, the yen and the British pound sterling. Two weeks ago, Christine Lagarde, head of the IMF, said that the renminbi was not quite ready for inclusion in the basket of securities the IMF uses for “special drawing rights” because China needed to make its currency more “freely usable.” And the policy change last week, by moving to a more market based valuation, is a step towards inclusion.

So, what does the devaluation and potential slowdown in China mean? In the long-run, it’s tough to say. In the short run, it’s another source of concern and uncertainty for investors. Uncertainty and doubt has been the mood of the markets since March, when strong economic data in the U.S. caused the Fed to start talking about increasing interest rates. That uncertainty was followed by the uncertainty about a possible ‘Grexit’. And, now we’ve got China. At other times, the devaluation might have been seen by investors as good news- that China now is using a competitive tool to stimulate growth. But, instead it was received as another uncertainty, which, together with the other concerns have caused stock markets to go sideways for over 5 months now.

Here’s a great example: Apple stock. On July 21st, Apple reported quarterly results that were “amazing”- revenues up 33% and earnings per share up 45%. Yet, investors focused on the lower demand for the iPhone and the smartwatch not meeting expectations. Apple stock has dropped 11% in the last four weeks.

It’s a frustrating time for investors. Some are quick to start extrapolating that the last five months of flat markets may extend for years. It’s a frustrating time for wealth managers, like DWM, as well. However, we know, as Barry Ritholtz pointed out in his Bloomberg column last week, time is our investing ally. People are often stuck in the short-term, focusing on recent events and projecting those out for the future. Just because the markets have gone sideways for the last five months, does that mean they will continue to languish indefinitely? Yet, despite its lack of growth the last five months, the world stock markets have been up over 15% per annum since March 2009. In the last 40 years, including the bust and the financial crisis in 2008/9, a diversified, balanced investment portfolio has likely increased more than 7% per year.

We know that in the long-term that the power of compounding is in our favor. Yet, that mathematical concept can be difficult to accept emotionally at times like this. It is now one of our chief jobs as total wealth managers to stress that it is important to stay disciplined, stay focused on the long-term, stay invested and not let emotions drive irrational behavior based on short-term events.

Bitcoin 101

bitcoinYogi Berra once famously said:  “The future ain’t what it used to be.”  So true. Amazon announced this month that purchases could be delivered to your doorstep by drones in a few years. And, it’s very possible that you won’t pay for them with U.S. dollars. You might be using Bitcoin, the new virtual currency.

Bitcoin (“BTC”) has soared into public attention this year as its price went from $15 in January to over $1,000 in early December. Actually, the basic concept of Bitcoin, a currency independent of governments and banks, dates back over 80 years to Thomas Edison. Mr. Edison not only was granted 1,093 patents, but he also was weighed in on economic issues. After World War I there were wide fluctuations in the value of the dollar and rampant inflation in much of the world. Mr. Edison distrusted banks and proposed a new monetary system using commodities as the underpinnings for a new currency. He and his friend Henry Ford called it “Ford-Edison Commodity Money.”  The idea was ahead of its time and didn’t catch on.

Fast forward to 2009. BTC software is developed by Satoshi Nakamoto (a pseudonym).  It allows users to send payments within a decentralized, independent peer-to-peer network. It does not require a financial institution or central clearing house.  Users simply need an internet connection and the BTC software to make and accept payments.

BTC fulfills some of Edison’s concepts:

  • It is backed by commodities- energy and time
  • The BTC network stores the transaction history inside a log called the “blockchain” which constantly grows as new records are added and never removed.  Though these are today cloud based, they are similar in concept to Edison’s proposed “commodity warehouses.”
  • It is (theoretically) inflation-proof

Early adopters have been computer geeks, libertarians, drug dealers and others world-wide. Now, BTC is attracting some surprising new fans. Fed Chairman Ben Bernanke said last month that it “may hold long-term promise.” A small but growing band of stores and companies are accepting payment in BTC, particularly internet companies in China. However, on December 5th, the Chinese government central bank effectively halted the use of BTC for Chinese business-to-business monetary exchange. BTC prices dropped 30% the following day.

Coincidentally, on December 5th, Bank of America Merrill Lynch became the first major financial institution to initiate analyst coverage of BTC. Their report started with the following: “We believe Bitcoin can become a major means of payment for e-commerce and may emerge as a serious competitor to traditional money transfer providers. As a medium of exchange, BTC has a clear potential for growth, in our view.” Further, they suggested that BTC will likely only have a limited role in black market/underworld transactions, since all transactions are public and every BTC has a unique transaction history that can’t be altered. BOA’s report also provided a valuation of BTC assuming it becomes a major player in e-commerce and a significant store of value (perhaps like silver). The report set the maximum value on one BTC at $1,300.

BOA also provided a nice recap of the advantages and disadvantages of BTC:


  • As a medium of exchange, it offers low transaction costs
  • As an alternative for cash, it has better security and more transparency of transactions
  • There is a finite supply of BTC
  • Its anonymity is advantageous to those in countries wanting to avoid controls or confiscation
  • It’s the first digital currency and while there will be others, it’s the current leader
  • For asset allocation purposes, it has a low or even negative correlation with the stock market


  • Its price volatility limits its role as a store of value
  • Regulators could impose controls over transaction costs
  • The quality of BTC exchange security is suspect. Hence, Bitcoin users/investors may be subject to both investment risk and credit risk.
  • Governments may halt or limit the use of BTC
  • It is not a legal tender- no one is required to accept them. Hence, its value is only as good as the perception of its worth. And, it is not a publicly traded security.

Bitcoin could become very important in the coming years. Or some other “cryptocurrency” may take its place. However, as Yogi also said, “it’s tough to make predictions, especially about the future.” Either way, we’ll be watching and reporting on the new phenomenon of digital currency as it plays out. Very exciting.

Love that Cash!

Love that Cash!Ever wonder where worldwide currency gets printed? Certainly, here in the United States, our U.S. dollar banknotes are printed by the Bureau of Engraving and Printing in D.C. and Fort Worth, Texas. Of course, our Federal Reserve keeps them busy. Like the U.S., most large countries do their own printing. The smaller countries, and those under a time crunch, outsource the job.

South Sudan seceded from Sudan on July 9, 2011. It needed currency quickly for its new country. Of course, like all cash, it would have no intrinsic value, but it needed to appear of value to inspire public confidence. The product needed to be durable and secure. South Sudan needed millions of copies of their six bills produced cheaply yet safe from fraud. Ten days later, on July 19, 2011, the government introduced the South Sudanese pound, which included the image of John Garang, deceased leader of their independence movement.

South Sudan couldn’t have accomplished this without De La Rue, a British company and the world’s largest commercial banknote printer. De La Rue got started in early 19th century, obtaining a Royal Warrant to print playing cards. Today, it also prints passports, drivers’ licenses, stamps and bank checks. Its customers include 36 central banks, including the Bank of England, the Bank of Greece and the European Central Bank. There aren’t many worldwide “security” printers. Trust is one huge factor. A long history and established relationships with central bank clients are others. De La Rue’s two main competitors also both date back to the 19th century.

The Wall Street Journal on August 13th reported that African countries want to replace the U.S. dollar with their own. Angola, Mozambique, Ghana and Zambia have all recently enacted laws to reduce U.S. dollars in their countries. In copper-rich Zambia, the central bank has banned dollar-denominated transactions and now requires the kwacha be used. They’re serious about this. Violators may spend 10 years in prison. The desire is more than national pride. Small economies like Zambia do not want complete reliance on foreign currency. It’s working. Their recent changes have heightened demand for the kwacha and have pushed their currency to its highest level against the dollar in more than a year.

The financial crisis has also been good for banknote printers. The collapse of Lehman Brothers in 2008 has led to people holding more cash. Around the world, low interest rates and fear of banks in general have resulted in more cash being stuffed in mattresses. Furthermore, if, in fact, Greece exits the euro, commercial banknote printers will undoubtedly be asked to produce, in secret, millions of drachmas in a very short time. And, can you imagine what would happen to the banknote printing industry if the euro zone splits apart?