Tags: China | devaluation | market | noise

Is China's Devaluation a Major Signal or Just Noise?

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Thursday, 27 August 2015 10:45 AM Current | Bio | Archive

History is full of seemingly minor events that turn out to be the first domino to fall to bring others down with it. This can then lead to very negative outcomes far beyond what could have been imagined from the seemingly innocuous initial event. Of course none of these events can have such disastrous consequences unless powerful forces have building up since nothing happens in a vacuum.

Some notable ones that come to mind are the assassination of Archduke Ferdinand of Austria that catalyzed World War I.

Nixon shutting the gold window in 1971 unleashed the inflationary forces that were building up for a number of years into an unprecedented peacetime wage and price spiral. This was further compounded by the Arab oil embargo in 1973 and 1974.

Jimmy Carter just said that if he had sent one more helicopter in to rescue the American hostages in Tehran it would have been successful and he would have been a two-term president. The fact that he wasn’t offered the opportunity for the country to have a polar opposite candidate in Ronald Reagan who was subsequently elected President and his supply-side convictions.

This unleashed the financial revolution that has resulted in an explosion in debt financing and the mantra to maximize the return to shareholders with a significant impact on America’s labor force and its declining share of national income.

One of the most underappreciated events in my lifetime was when Hungary opened its border fence with Austria (yet again) in May 1989, unleashing a tidal wave of people from the Soviet satellite states of Eastern Europe to Hungary to escape to the west. This turned out to be the key event which led to one regime after another falling and ultimately the Soviet empire collapsing.

Two Bear Stearns credit funds going under in 2007 turned out to be one of the events that opened investors’ eyes to the riskiness of exotic credit instruments and how much of overvalued paper could be floating around the world. The subprime crisis snowballed into an avalanche and the global economy almost went under during the Great Recession.

A more recent example is the Saudis announcing they were not going to cut oil production in the face of clear oversupply. This was an unequivocal declaration that they were going to defend market share at all costs regardless of price. Oil began its collapse after that announcement. This is a less subtle example of a catalytic event.

Investment success accrues to those who can separate the signal from the noise and can connect the dots to determine when an event is a trigger to much more powerful outcomes (both good and bad). So the question on the table is whether the devaluation of the Chinese currency is one of those seminal events? With trillions in paper wealth having evaporated it clearly has in the short run.

But what about in the long run? Is this more akin to 1998 when the U.S. economy and markets shrugged off the Asian currency crisis after a nasty correction only to propel higher on the back of the dotcom boom or something more similar to 2007 and the subprime implosion?

Since I have reached my word limit, I will let you ponder it and would love to know your thoughts.

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GaryCarmell
History is full of seemingly minor events that turn out to be the first domino to fall to bring others down with it. This can then lead to very negative outcomes far beyond what could have been imagined from the seemingly innocuous initial event.
China, devaluation, market, noise
549
2015-45-27
Thursday, 27 August 2015 10:45 AM
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