Forex Market Explained
Much of the currency movements of the last 2 weeks find their causes in the spate of interest rate cuts in China that led to a devaluation of the nation's currency the Yuan. Like a ripple the devaluation of the Yuan led to a sell off in Chinese equities and then traders compounded the negative sentiment by selling off European and American equities in search of safety in US Treasury bonds and German Bunds. That had the effect of knocking the EUR/ USD into a temporary mis-alignment of relative currency values across the globe.
At the very heart of the problem of international trade lies the concept of the consumer. When equities traders ran away from China what did they see? Essentially let us get back to economic basics to understand why currencies move.
China may have become the second largest economy in the world today in terms of GNP value; however that belies the lack of sophistication that can be exhibited in developed economies such as USA. Japan and Europe. The difference between an economy like Europe and China is to do with the concept of the consumer. In Europe, the European economy is finely balanced between exports and imports because the consumer has a high level of per capita income. In China the economy is geared to exports only with a low level of consumer per capita income. Should Europe, USA and Japan switch off the needs for Chinese exports then pretty much the Chinese export industry becomes stuffed with only the smaller markets left to absorb their exported products. The very heart of the China problem today is that the consumer cannot afford Western imports and so the entire Chinese economy has a mismatch of currency flows.
A quick recap of the Chinese problem points to consumer problems of growth of per capita income. China has to export and to do so it needs to keep its Yuan low relative to other currencies and it has to keep wages low to keep competitive costs of production. Low wages do not raise per capita income; consequently the Chinese consumer is unable to become a market force to balance the export industry. So in terms of economic structure; China becomes riddled with several problems of noncompetitive industry, problematic bank sector and housing market glut unable to harness the power of the Chinese consumer to grow a domestic way forwards to raising the standard of living and per capita income. The key to raising the Chinese consumer and maximize the theory of utility lies in opening up the economy to foreign investors which requires a stable equities market. The PBOC rate cuts have done little to restore the confidence of international investors let alone attemnpt to solve the issue of the impoverished Chinese consumer. Until the Chinese consumer can see his real wages grow then the Chinese economy cannot reflect the level of sophistication of economy as exhibited in USA, Europe and Japan with growing per capita income of consumers and efficient debt markets to service the equity markets to meet consumer demands.
For a quick recap of Consumer Theory to help you understand the economic basis behind currency movements please download here from Bookboon - Essentials of Microeconomics by Krister Ahlersten and read section 4:
Pieter Bergli - DeLoren Trust Holdings
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