Why do we care about currency fluctuations?

With all the recent press about China devaluing their currency, you might be wondering what all the fuss is about. In this case, it is mostly political. With Trump’s tariffs set to go into effect, China is looking to retaliate by devaluing their currency – thereby making their products cheaper.

Here’s how the math goes. Before the latest devaluation, it cost about 6.9 Chinese Yuan for every US Dollar (USD). So, let’s say something was selling for 6.9 Yuan and an American company planned to import it. They would convert their $1 USD to 6.9 Yuan and the transaction would proceed.

Now apply a 25% tariff. Assuming the manufacturer doesn’t lower the price to “eat” some of the tariff, that same product would now cost the American company $1.25 with 25 cents going to the US government and the same $1 going to the Chinese manufacturer.

But now China devalues its currency (as it has just done) so that $1 US equals 7 Chinese Yuan (it is actually a bit more devalued but we’ll make the math easier by using a whole number). That product that still costs 6.9 Yuan, now converts to $.985 USD. Adding the 25% tariff makes the total cost $1.23, or a savings of 1.5%. In effect, China just blunted the effect of the tariff a little. More importantly, they’ve sent a political message to Trump that they can respond economically to America’s economic sabre rattling. In other words, they could keep devaluing their currency to combat the tariffs.

So, what does this mean for Canada? As usual in the world of economics, it is good news and bad news. The good news is that Chinese products are suddenly a few percent cheaper, lowering the input cost for many Canadian companies and Canadian consumers. The bad news is that if the US/Canadian dollar exchange rate stays stable (this is not a good assumption but the situation gets really complicated if you don’t assume this), then Canadian products and services are more expensive which makes them less attractive in China. Chinese tourists are going to find Banff a bit more expensive (as if it wasn’t expensive enough already!) and your Canadian dollar will go farther if you plan to visit China.

Not a big impact on Canada and Canadians and really a political game but how the game is played is interesting.

#monetarypolicy #interestrates #investing #world #StockMarket #Currency