Question

China has taken some hits, but may still prove a force to be reckoned with. Emerging markets could benefit from China resurgence. Lisa Shalett Wealth Management Head of Investment and Portfolio Strategies Morgan Stanley August 6, 2018 As global growth slows, trade tensions continue to escalate and emerging markets falter, investors have good reason to wonder if China is the force it once was. China is likely central to how trade, currency fluctuations and the global growth outlook may ultimately play out. The consensus among investors now seems to be that China is slowing, the yuan weakening and emerging markets are best avoided. Emerging markets are down 6% year to date in contrast to a rise of 6.5% in U.S. equity markets. While investors may assume current trends will persist, I’m not convinced. The situation now is very different from late 2015 and early 2016 when China’s currency devaluation collapsed commodity prices and emerging markets. Plus, China has several levers it can pull if market conditions deteriorate and I am inclined to believe they will use them if necessary. China can stimulate its economy using monetary policy, allowing its currency to depreciate (which makes its goods more competitive globally) or encourage credit growth. China also holds $1.4 trillion in U.S. Treasuries and controls key global supply chain links for many U.S. companies. So far, China’s economy has merely slowed—and not much more than the amount desired by its policymakers who have sought to avoid a so-called hard landing from the torrid pace of growth earlier. That’s why I don’t expect game-changing policies. However, I think China has the tools to reverse the recent trends, which may well lead to positive surprises for emerging markets. Bottom Line: Emerging markets have sold off and investors who have maintained their portfolio holdings may now have less exposure than is optimal. I think this is a good time to square up. Valuations make the case—I calculate that emerging markets equities are selling at a 27% discount to developed markets. Moving forward, China may well engineer some positive economic surprises that lift developing markets more broadly.

Questions

1 ) The article states “...late 2015 and early 2016 when China’s currency devaluation collapsed commodity prices and emerging markets.” Why would China’s currency devaluation cause commodity prices to collapse? Why would it cause emerging markets to collapse?

2 ) The article states “China can stimulate its economy using monetary policy, allowing its currency to depreciate (which makes its goods more competitive globally).” Why would a depreciation of China’s currency make China’s goods more competitive globally?

Answer 1

1. A devaluation of currency reduces the relative prices of domestic goods and services and makes them cheaper for rest of the world. This would cause emerging markets to collapse as relative price level of Chinese goods would fall, leading to an increase in demand for chinese goods and reduced demand for goods fr emerging markets, leading to a collapse of emerging markets.

2. Depreciation of Chinese currency would make it cheaper for foreigners to buy Chinese goods. As a result, demand for Chinese goods and services would increase, making chinese goods more competitive globally.