Felix Zulauf: Chinese Devaluation is a Turning Point in the Currency War

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On August 18 – Jim Puplava interviewed Felix Zulauf, the Founder and President of Zulauf Asset Management AG in Zug, Switzerland. The interview is about the currency devaluation in China and its broader implications…

The recent depreciation of the yuan is not an isolated case, but it points to a turning point in China‘s monetary policy. That was shared by the hedge fund managers and investment star Felix Zulauf in the interview at Financial Sense.

The Chinese currency has a major problem because it was focused too much on the dollar, which has gained so much strength and is in very strong uptrend. On the other hand countries such as Japan and other Asian countries have their currency devalued massively in the last twelve months. This has put enormous pressure on the Chinese export enterprises, said Felix.

The Asian country is on the shady side of the business cycle and thus in a period of downturn. The latest figures on the economic situation were not real, he believes. China’s economy is growing not by 7 percent but probably at 2 percent.

The central bank in China had decreased in the past week the daily reference rate by 1.9 percent, which triggered the biggest daily price drop of the yuan since January 1994th. Previously, China had supported the course to make outflows unattractive. In addition, Chinese companies who are in debt in foreign currencies,were protected but that’s not the case anymore.

Thoughts from FinancialSense Big Picture podcast, Currency Wars and the Chinese Devaluation, featuring guest experts Felix Zulauf and Marc Chandler, which you can listen to in full at Financial Sense here or on iTunes here.

Many investors are wondering whether the recent move by the Chinese central bank signals the start of a new currency war. Will it be the start of another banking crisis and market collapse, as some predict, or are these fears overblown?

Flood of Liquidity Moving Back West

Felix Zulauf sees the flood of liquidity and investment that once found its way into China and other emerging markets now in the process of heading back towards the West. Zulauf reminds us just how important this is given that China experienced the “biggest investment and credit booms in mankind’s history,” which is and will continue to have major repercussions on global markets as the Chinese economy slows down.

As many others, Zulauf believes China is growing much slower than official figures suggest and cites 2% as a possible number—far less than the official 7% growth figures. Because he sees further weakness ahead, Zulauf is very confident that the total renminbi devaluation will eventually reach at least 20% against the US dollar in the years ahead.

Zulauf is concerned about several potential risks associated with this: Enormous capital outflows from investors seeking a more stable currency is one possible risk; another is a lack of domestic liquidity caused by the Chinese central bank selling dollars; and still another worry is the deflationary impacts this will have on markets around the globe. Zulauf believes most outsiders have been “brainwashed” to believe Chinese economic propaganda claiming that China is in a stronger position globally than is in fact the case. If investors or other economic actors all of a sudden change their mind, or lose confidence in the strength of the Chinese economy, the fallout could be difficult to contain.

Banking Crisis

Zulauf laid out the following scenario as a sort-of worst case scenario:

“What we haven’t seen yet is a banking crisis…You have tremendous carry trades in the Asian financial centers. The Singaporean banking industry has grown its loans from 70-80% of GDP to 160% of GDP in the last 5-6 years and the same has been going on in Hong Kong. A large part is geared to China. They are in a carry trade…. If currencies move more than expected you usually have fallout and victims…. All of a sudden some of the banks may come up and say, ‘Listen guys we have non-performing loans on the order of 20% [of capital].’ Once that hits the newswires, then I think the world may wake up and realize that perhaps we have more than a 2 or 5% devaluation on our hands. Maybe we have systemic risk here…[since] banks in Singapore, Hong Kong and China are interlinked with banking systems in the western world.”

Zulauf qualifies this pessimistic assessment, though, by admitting that the US dollar and US stocks are likely headed higher after an initial deflationary scare. He feels this way in part because of similarities to the Asian currency crisis of the late 1990s: in that instance, even with all of the volatility caused by a surprise collapse of the Thai baht, the response of western central bankers helped many markets—especially the Nasdaq Composite—to surge relentlessly higher. Yet, as was the case at that time, the bull market was selective: it excluded most commodity names, as well as emerging markets. Zulauf feels investors should keep that example in the back of their minds over the next several months when dealing with the consequences of the Chinese devaluation.

Mr. Felix Zulauf is also a long-standing member of the Barron’s Roundtable where every year he shares with the world his view on investment and economic matters.

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