President Trump shocked markets last week when he announced new tariffs on Chinese goods. China has now retaliated, artificially devaluing its currency to remain competitive.
Investors responded to the news with the Dow Jones shedding more than 500 points after the open of Monday trading.
Chinese Yuan Lowest in a Decade
China let its currency fall this morning, leaving 1 Chinese Yuan equivalent to 0.14 US Dollar. This is the first time in eleven years that the Yuan has been below a 7:1 ratio with the greenback. Analysts are now calling this a currency war, accusing China of weaponizing the Yuan in a response to recent tariffs.
A weakened Yuan helps China by making its export prices extremely low. This hurts competition in both China and in the markets where it trades. China’s weak currency has been a major point of contention in trade negotiations this year.
President Trump took to Twitter to criticize the Chinese move, saying that “China dropped the price of their currency to an almost historic low. It’s called “currency manipulation.” Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!”
Double Effect for China
Lowering the Yuan makes Chinese goods more competitive overseas, but it also hurts the domestic market. Foreign companies doing business in China will now find it more difficult to compete. This is why so many analysts have seen the currency drop as an aggressive move.
Currency devaluation also illustrates why American businesses have become more interested in producing in China for the domestic market. Tesla (NASDAQ: TSLA) recently started work on a Chinese factory for its electric vehicles. This factory will protect Tesla from tariffs while also negating the effects of a weakened Yuan. If the company can source most of its parts and materials from within China, it will remain competitive.
Yearly Gains are Still Strong
Despite the worsening trade situation, gains for the year are still impressive.
- The S&P 500 Index is up 14.51% year to date.
- The NASDAQ Composite is up 17.42%.
- The Dow Jones Industrial Average is up 11.25%.
Last week was the worst of the year, with indexes suffering Monday through Friday. The current situation is worryingly reminiscent of 2018, when trade tensions and interest rates triggered extreme volatility before the post-Christmas recovery.
Investors should avoid emotional responses to the current news and think long term before making any buy or sell decisions. Current stock movement is not an accurate reflection of the better than expected corporate earnings that have been seen in 2019.
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