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Weekend Reading

August 14, 2015

With a lack of compelling headlines coming from Greek debt negotiations and no exciting news out of the U.S. Federal Reserve, it looked like this week would be another summer snoozer.  Fortunately for the financial soap opera fans out there, China came through and delivered the drama.  On Tuesday, China surprised the world by devaluing their currency (the renminbi/yuan).  The move caused ripples in markets across the world as many feared it was a sign that the Chinese economy was in much worse shape than previously believed.

So what is all the hoopla about?  Why has Donald Trump been complaining about China for years?  What makes China's currency so different than other common currencies?  High level explanation coming up...

The Chinese yuan is not freely traded.  Instead of supply and demand determining its value, China's central bank sets the valuation based on a formula that is "pegged" to the U.S. dollar (USD).  Why peg to the USD?  For an emerging economy, pegging your currency to the world's reserve currency is one way to provide greater stability within a developing monetary system.  

For many years, China pegged the yuan at an artificially low valuation.  Because the yuan was undervalued in terms of USD, China could export lots of cheap goods to the United States.  This bothered many people because it gave Chinese companies an unfair advantage over their U.S. counterparts.  In 2005, under pressure from the international community, China began allowing the yuan to slowly appreciate and by 2014, the IMF considered the yuan to be fairly valued.  Despite its fair value, China has always maintained strict controls over the currency and it is still somewhat pegged to the USD.

Back to this week...

Why did China decide to devalue the yuan?  Well, over the past year, on the back of a strong U.S. economy, the USD has increased in value by nearly 20%.  The yuan, still being closely tied to the dollar, followed suit.  The Chinese economy however, has been weakening, and a slowing economy with a rising yuan is problematic.

With a strong yuan, Chinese goods have become more expensive in other parts of the world.  Higher cost leads to less demand.  Slowing demand has led to fewer exports and this has been an added drag on the fragile economy.  By devaluing the yuan, the Chinese government is hoping to jumpstart Chinese exports  by making them more affordable (thus attractive) in other parts of the world again.

So if devaluing the yuan is going to help China, then why did stock markets around the world sell off on this news?  Well currency valuations work both ways.  When the yuan depreciates, the rest of the world can buy Chinese goods cheaper.  But, a cheaper yuan also means that goods from Europe and the United States will be more expensive for consumers living in China to buy.  There are A LOT of consumers in China.  In fact, China is the third largest importer of goods in the world.  If those goods are more expensive, that means less demand for European and U.S. products.  How much less demand?  It could be significant enough to impact the economies of many other nations who rely on China for sales.  If you weren't aware, the Chinese buy a lot of iPhones.

In the grand scheme of things is this really a big deal?  I doubt it.  Most people have been begging the Chinese for years to loosen the USD peg and let market forces price the yuan.  That is exactly what they are doing, albeit slowly.  To me, the "Currency War" doomsday headlines are driven more by 24/7 newsrooms starving for stories during the slow summer months, than the real possibility of a currency crisis.

Anyway, if you didn't understand how foreign exchange markets affect international trade, I hope you now have a better idea.  Have a yuan'derful weekend!

It's 5 o'clock somewhere...


Market Cocktail Talk

China Devalues Yuan - The surprise move by China to devalue its currency sent shockwaves through global markets, dragging down stocks and commodities as investors speculate the move was timed to combat a deepening slowdown in the world's second largest economy.


Ryan Broyles knew NFL players, and athletes in general, go bankrupt.  He saw athletes blow through millions and was determined not to have it happen to him.  Despite signing a $3.6 million contract in 2012, Broyles and his wife live on a budget of $60,000 per year and save the rest.

It all started after a meeting with a financial advisor soon after being drafted in 2012.  The advisor gave Broyles some advice he used to shape his life: Spend as you would like over the next few months.  Figure out your means.  Then set a budget, live within it and invest the rest.
 
 

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Each week I provide brief commentary and link to a few articles I thought were worth sharing.  The goal of Weekend Reading is to keep our readers engaged and up-to-date with the world of finance in a quick and easy format.  If you are interested in learning more about Ariadne Wealth Advisors and the services we provide, visit our website and never hesitate to reach out.  Have a great weekend!

-Tim


The information provided above is general in nature and is not intended to represent specific investment or professional advice. No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from Tim Brennan or Ariadne Wealth Advisors which can only be provided through a formal advisory relationship. Please see our website at http://www.ariadnewa.com for more information about Ariadne and our investment philosophy.

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