The tit for tat between China and the U.S.

When the economy truly became global, no longer was it simply a case of if the U.S. sneezed, the rest of the world caught a cold.  Nowadays, it is the American economy that can fall ill when economies in Asia or Europe skin their knees, bump their noggins, or catch a fever.And this paradigm cannot be more evidenced where just this last week, China did three relatively minor monetary moves to their currency that caused panic in some quarters of the U.S. and European markets, despite the fact that these adjustments were in most cases less than 5%.

The Dow closed 211 points lower, after dropping as much as 250 points earlier in the day, while the S&P 500 and Nasdaq were also in the red on Tuesday. Markets in Europe and Latin America fell too.

The People's Bank of China allowed the yuan to depreciate by nearly 2% against the U.S. dollar, the largest devaluation in two decades. China described the move as a one-off piece of market-reform, but many see it as a way to boost exporters and its cooling economy.

The move rippled through global markets and slammed stocks of many companies that sell goods in China, though some companies are set to benefit. The move also affected the exchange rates of several global currencies. - Money.CNN

China would later devaluate their currency one more time, while then backtracking and raising it on a third day by a tiny margin.

Pundits of course tried to downplay these moves as being a natural part of China's economic cycle as their growth rate has slowed over the past quarter due to an overall slowdown in global consumer confidence and overall global demand.

global consumer confidence

However, behind the scenes Western central banks know that this Yuan devaluation is just the next phase of the ongoing global currency war that V forecast several years ago.  And already the Fed, BOJ, and the ECB are queuing up a new round of Quantitative Easing to try (failing of course) to stimulate the economy out its current deflationary spiral.

In particular, financial developments in China could have a larger than expected adverse impact, given this country’s prominent role in global trade.

Consider that, and consider the following statement sent to Bloomberg by an adviser to Japanese PM Shinzo Abe:

If [the Chinese move to devalue to yuan] suppresses external demand in Japan too much, the BOJ may further relax monetary policy.

Clearly, the ECB meeting took place ahead of China’s FX shocker, so the governing council’s reference to "financial developments in China" likely referred to the stock market collapse that was unfolding at the time, but the takeaway is the same: if developments in China’s financial markets serve to further undercut Japan and Europe’s quest to boost growth and stoke inflation (i.e. if China succeeds in exporting its deflation to trading partners), more QE and more easing will be just around the corner. - Zerohedge

The significance of this is... suddenly, the West is no longer controlling global monetary policy but is instead reacting to the actions taken by China, who seems to have wrenched that control from the impotent Western central banks.

Corporate Bond Crash worst since Lehman after Yuan Devaluation

corporate bond devaluation

Since China announced an update to their gold reserves, they have been prodding the U.S. and Europe with small pin pricks to see what reactions it would have on the fragile Western economies and monetary systems.  In fact, if China had really wanted to do some serious damage to the global economy they could have instituted more drastic corrections such as announce much higher gold reserves, increase their dumping of dollars, lowered their interest rates (which are still at or above 5%), and or as an extreme measure, completely un-peg their currency from the dollar.

The problem for the U.S. is that they have already played most of their cards, and are left resorting to military responses in retaliation of economic threats.  The sudden explosion last week of the Chinese port of Tianjin has many speculating that the West had a hand in this horrific event, and may have been in retaliation to China's devaluation moves earlier in the week.

China has relied upon the American and European consumers for their lifeblood of trade and commerce for many years, but the days of needing to appease this segment of their economy is quickly coming to an end.  Declines in global consumer spending, coupled with the overall deflationary indicators showing we are now in a worldwide recession, has left China with no need to hold a stable relationship with the dollar and with the U.S., especially as the world accelerates its own 'beggar thy neighbor' policies to protect their own, and bring about a new cycle of protectionism.

Plans are only as good as the drawing board when the first shots are fired, and then the battlefield becomes a fluid enterprise of adapt and change.  And just like in chess, one rarely moves out the queen and rooks when they can accomplish strategic advantages simply by blocking an opponents moves with the positioning of pawns.  And make no mistake, recent actions by China and the PBOC have been minor stratagems done with minor pieces, but when your enemy is already down half his artillery, the smallest of moves can achieve severe and catastrophic damage.

While making its devaluation announcement, Beijing said that it wanted its currency “to reflect fundamentals” and to no longer simply mirror the movement of the dollar. It acknowledged the fact that its peg to the dollar was problematic and that it wanted a better, more natural mechanism. This is the key to understanding the announcement: The Chinese are preparing for a time in which the financial world does not spin in orbit around the dollar. Such a reality must make us think about the future. - Peter Schiff