End of the Industrial Super-Cycle

There’s an issue, or an unstated assumption, which underlies much of the current worry about the state and direction of the world economy. One way of appreciating it is asking the question: ‘How can the US economy still be expanding vigorously when its industrial sector is in such trouble?’

Consider the evidence. US industrial output has shown consistently negative momentum since 4Q14 and this shows few signs of reversing: in August output fell 0.4% mom, and the regional industrial surveys for September have been grim, with the Philadelphia Fed survey shocking at minus 6 , the Empire State manufacturing survey grim at minus 14.7, the Richmond Fed survey showing minus 5 (worst since January 2013), and the Kansas City Fed manufacturing survey showing minus 6.  At the same time, inventory/shipment ratios have risen to the highest levels since 2009, so far without improvement;  capacity utilization rates have tumbled from a high of 79% in November to 77.6% in August. Exports, meanwhile, have endured consistently negative 6m momentum trends since July 2014, and by July 2015 were falling 7% yoy.

Despite this, domestic demand indicators have remained on balance positive, and, in particular, labour markets have remained robust. In the face of the most dramatic trade/industry downturn since the great recession, 2Q GDP growth came in at 3.9% annualized, largely on the back of a 3.6% annualized rise in personal consumption.

The contradiction between what is happening in the industrial sector and the trajectory of the broader US economy shows up clearly in my momentum indicators.

This divergence between the industrial sector and the overall economy is fairly obvious in the US. What is less obvious is that something very similar is characteristic of the entire global economy.  

As the chart shows (*see below for details on these indicators), on a global basis, the industrial sector is clearly in trouble, but despite that, domestic demand momentum is not merely being maintained, it continues to accelerate slowly, as it has for much of the time since early 2014. 

It seems to me that the most important thing about this aspect of the global economy is to acknowledge that it is really happening, and has been happening for nearly a year now.  There is a deeply entrenched expectation that where the industrial sector leads, the rest of the economy must inevitably follow, from which it follows that a description of the industrial sector cycle is adequate to locate an economy’s current trajectory and potential.

Part of the reason for that is that economists (and everyone else) feel far more comfortable analysing the industrial economy than the services sector.  At the  most basic level, industrial output is far easier to count, movements in industrial prices are far easier to observe, balance sheets of industrial companies easier to take apart, all of which has allowed us a very good idea of how business cycles affect industrial companies.  Similar analysis of the services sector fails at the first hurdle - even counting the output is so uncertain that we rely on hard-fought and contestable conventions and inferences, rather than direct observation. As for pricing, inventories, capital involved. . . .

Historically, there have been good historical reasons for the expectation that where industry leads, the rest of the cycle will follow, and what’s more, over the last 20 years new life has been breathed into those reasons by China's rise.  Nevertheless, the expectation is, in philosophical terms, not necessary but only contingent - and it may be that as China has got richer, the contingency is passing. 

Consider how spending patterns in the US have changed. In 1950, spending on goods accounted for 60.7% of all personal consumption spending, with services accounting for only 39.3%. However, as incomes rose, so the proportion spent on services rose, until in the 12m to June 2015, the proportions were almost exactly reversed, with 67.2% of personal spending going on services, vs only 32.8% on goods. But even that exaggerates the importance of industrial sector supply, since two thirds of spending on goods is on ‘non-durables’ such as food and gasoline. In fact, spending on durable goods accounts for only 10.8% of US personal consumption spending.  This helps explain why a loss of momentum in the US industrial sector need not necessarily be pointing to a wider economic slump. 

Such a pattern should surprise no-one: as a society grows wealthier, so marginal demand shifts from the acquisition of goods to the consumption of services. 

One should expect to find this shifting pattern of demand not just in the US and Europe but, of course, in Asia too.  And given the extraordinary rise in material comfort in China over the last 20 years, one should expect a similar pattern of shifting demand there too.  Although we do not have the data to show this directly, the changing composition of China’s GDP makes it clear that this process is underway.

In 1995, secondary industries (ie, principally manufacturing) accounted for 46.7% of GDP output, whilst tertiary industries (ie, principally services) accounted for 33.6%.  By 2015, the ratios had changed so that tertiary industries accounted for 48.6% of output, whilst secondary industries accounted for 42.2%. But note that as far as domestic demand is concerned, China was also running at trade surplus of approximately 5.5% of GDP, suggesting that domestic demand for secondary industry products had probably sunk to around 36.7% of GDP. 

The shift in underlying demand is even clearer when one looks at marginal contributions to GDP: in 1995 tertiary industries accounted for about 29% of marginal GDP growth; in 2015 that had risen to 68%. 

This shift in Chinese marginal demand away from goods to services, although predictable, is nevertheless the signal that the forces which drove the commodities ‘super-cycle’ - the sudden emergence of demand for goods from a Chinese population transitioning from poverty to material decency -  are no longer the primary forces driving either the commodity cycle, the global industrial sector, or indeed, the world economy.  When China first started emerging from grinding poverty to mass material decency, it was predictable that the first priority for China's population was to acquire more 'stuff'. So it made sense to buy the stuff that made 'stuff' - hence the commodities super-cycle.

But as China's population has grown richer, its marginal demand has shifted from 'more stuff' to 'better services'. Crudely put, its the shift from a new shirt to a sharper haircut.  Unless industrial companies have factored in this slight slowdown in the rate of growth of marginal demand from China, the industrial sector will discover it cannot win the return on capital from its capex that it originally expected.  On the other hand, demand for services will continue to grow relatively unimpaired.

In these circumstances, disappointing industrial demand and all that goes with it can easily co-exist with continued growth of employment, and overall demand in the world economy. 

* (My global momentum indicators for the industrial sector and for monetary conditions take in data from the US, Eurozone, Japan and China; the global domestic demand indicator also includes data from the UK, S Korea and Taiwan. In each case, the indicator measures standard deviation movements from historic seasonal trends for key data. For the industrial indicator, this includes output, exports (local currency value and volume) and where possible indicators for inventory ratios and capacity utilization rates. For domestic demand, I include retail sales, vehicle sales, employment, wages, and selected other indicators where possible. For monetary conditions I include growth of monetary aggregates, movements of the currency vs the SDR, movements in real interest rates and changes in the shape of the yield curve. In each case, for global aggregates, countries are weighted according to 5yr average of US$ denominated GDP.   No single-figure indicator will be perfect, but I am confident that these are sufficiently information-rich to not be completely wrong.)

Cargo-Cult Companies - Japan's 2Q Duponts

The MOF's 2Q survey of private sector balance sheets and p&ls reveals this: more than ever before, corporate Japan's ROE depends only on the ability to source supplies cheaply, and there is little sign it wishes to change this business model or expand its reach. It is a cargo-cult approach, in which all depends on the vale of what washes up on Japan's shores.

On the downside, this confirms that Abenomics' hoped-for rejuvenation of the Japanese economy is nowhere to be seen. On the upside, in the short term, a devaluation of the Rmb will probably aid Japanese profits, rather than erode them as I initially thought.

The 2Q private survey presents a picture of extremes:

• the highest operating margins since my data starts in 1980; 
• the lowest asset turns since my data starts in 1980; 
• the lowest financial leverage since my data starts in 1980. 

At the moment, the gains in operating margins trump all else, raising ROE to 10.4% (just below the post-200 average) and ROA to 3.9% (1SD above the post-2000 average). So it is probably no surprise that as the key ratios which determine return on equity scale off in both directions to to previously unseen extremes, there is no sign of any change whatsoever in corporate behaviour.

And what does it all add up to? Operating profits growth running at just 7% yoy on a 12m basis, and investment in plant and equipment up just 5.5%, only just enough to cover the depreciation allowances claimed.

In 2Q sales rose 1.1% yoy (1.4% 12ma) whilst operating profits jumped 20.5% yoy (7.4% 12ma), and as a result, margins rose to 4.81% (vs 4.52% in 1Q), and 4.3% on 12m. These are the fattest operating margins for Japan since my data begins in 1980.

The reason for the rise in margins is simply an improvement in corporate terms of trade, with the cost of goods sold ratio falling 0.9pps qoq to 76.4%, the lowest since at least 1980 (although on a 12m basis, the 77.3% ratio was matched in 2Q11). There is no further improvement in SG&A /Sales, with the ratio rising slightly to 18.8% (vs 18.2% in 1Q and 18.7% in 2Q14). And there was practically no further improvement in the sales/expenses per employee ratio, as sales per employee fell 3.1% yoy whilst expenses per employee fell 3.4% yoy. 

Both asset turns and financial leverage continue to decline to new lows. Total assets rose 5.2% yoy and 5.9% 12ma whilst sales rose 1.1% yoy and 1.4% on a 12ma, so annualized asset turns fell to 0.87, from 0.95 in 1Q and 0.91 in 2Q14. On a 12m basis, asset turns fall to 0.906x, the lowest since 1980s.

Whilst total assets rose 5.2% yoy in 2Q, shareholders’ net worth rose 6.5% yoy, so financial leverage fell to 2.63, or 2.66x on a 12m basis: again, the lowest since 1980 at least. The cash portion of that net worth continues to rise, up 8.6% yoy in 2Q, equivalent to 11.4% of total assets, or 11.3% on a 12 basis - the highest proportion since 1992 in the immediate aftermath of the zaiteku financing bubble years.  Those cash holdings strip 4.5 percentage points from return on equity, cutting it to 10.4% from the ex-cash ratio of 14.9%. 

US Capital Goods Winter Thaws in July

There was enough in July’s capital goods data to remove most of the clouds which have hung over the investment cycle for the last six months. In July capital goods (nondef ex-air) orders jumped 2.2% mom, whilst shipments rose 0.6% and inventories fell 0.1% mom. The orders recovery was broadly-spread: autos rose 4% mom, computer/electronics rose 2% mom, machinery rose 1.5% and electrical equipment rose 1.3%.

The result is that the book/bill ratio recovered back to 1 for the first time since January, and the inventory/shipment ratio fell to 1.73x, also the lowest since January. Although this does not entirely remove all threats from the capital goods cycle, it does suggest the immediate pressures have been relieved.

In particular, inventories of capital goods have been kept essentially flat since September 2014, and with the inventory/shipment ratio now a full standard deviation lower than the post-2010 trend, any significant recovery in end-demand stands to be amplified by a rush to re-stock supply channels.

Still, for the capital goods sector, 2014-15 was a long long winter, and even July’s results are not stellar. In particular the book/bill ratio is still a full standard deviation below the post-2010 average. More, although orders rose a revised 1.4% mom in June and a further 2.2% in July, it still leaves the dollar total down 3.3% yoy and 6.6% below the 2010-2014 growth rate.  Similarly, although shipments rose 0.9% mom in June and 0.6% in July, in dollar terms they were up only 0.5% yoy in July and are 5.3% below the 2010-2014 trend.

China and Commodities - The End of the Beginning

I suspect the market is wrong about China, and wrong about its likely appetite for industrial commodities in the coming year - most likely the bottom has already been and gone.

To start with two things which should be obvious: the Caixin manufacturing PMI for August, which apparently managed to panic markets when it fell by 1.7pts to 47.1, is produced by Markit.  China’s industrial data is insufficiently consistent to allow the tests, but where one can measure - Europe, UK and the US - there not the slightest scintilla of meaningful correlation between movements in Markit’s PMIs and movements in industrial output. I do not doubt these indexes power to move markets, but their information content is right up there with astrology: they are not even wrong.

The second thing which I think is obvious is that China’s willingness to devalue the Rmb is a correction of a quite serious monetary policy mistake made last year, and was a necessary precondition to re-liquefying the economy. There are clear signs that PBOC is now grasping the opportunity, adding 150bn yuan in open market interventions this week, the largest since Chinese New Year’s temporary 205bn yuan injection, and compared with the average weekly rise of just 6bn yuan during the last three months.  On top of that, the week has seen PBOC extend 110bn yuan in medium-term loans to 14 financial institutions, and also pump $48bn into China Development Bank and US$45bn into China Exim Bank.

China has finally granted itself the conditions under which it can reflate the economy, and it looks like the central bank is finally making an attempt.  If it succeeds, then the track record suggests that eased monetary conditions will be able to restore momentum in both the industrial sector and in domestic demand.

If so, this is the end of the beginning of China’s cycle, rather than the beginning of the end.

In which case, the current panic in commodity markets looks misplaced, since Chinese demand for industrial commodities is more likely to stabilize and/or rise during the coming year than to disappear.  In fact, that trajectory may already be emerging in the relevant data, such as  imports and inventories. 

The place to start is with the volume of China’s imports of industrial commodities. For those commodities which are no longer growing, imports topped out early in 2014, since when they have been either stagnant or falling. But by July, that peak is beginning to pass out of the base of comparison, with the result that yoy falls are beginning to moderate and will continue to do so, even if the recent signs of modest growth disappear.  In July, imports of four out of the six major industrial commodities showed a yoy rise in volume terms.  

1. Crude Oil: up 29.3% yoy, and up 10.4% ytd
2. Refined products: up 28.5% in July, and up 0.9% ytd
3. Iron ore: up 4.3% yoy in July, and down 0.1% ytd 
4. Copper: up 2.9% yoy in July, and down 9.4% ytd
5. Coal:  down 7.7% yoy in July, and down 34.1% ytd
6. Steel Products: down 13.9% yoy and down 8.9% ytd

We can also get some clues from Australia’s trade patterns: during June exports to China rose 3.4% yoy, although in the year to June exports to China were down 17.7% ytd. Now, looking at commodities: in A$ value terms: 

1. Iron ore down 10.9% yoy in June and down 32.1% ytd
2. Coal: up 13.7% yoy in June and up 1.7% ytd
3. Copper: down 21.4% yoy in June and down 24.2% ytd

The message is similar: although the market is soft, the later data suggests things are moderating, not getting worse.

There’s more to this moderation than simply a base of comparison effect. In addition, the inadvertent tightening of monetary conditions during 2H14 and early 2015 squeezed working capital hard enough to make China’s companies in turn squeeze their supply chains (hence the toll on Northeast Asian suppliers) and cut inventory holdings. There are a variety of measures of China’s inventories, but most agree that commodities inventories have fallen, quite sharply. Of the three separate measures of iron ore inventories, two find them down 26.8% yoy in July, and one finds them down 29.5%. Rebar inventories are down 3.4% yoy, and hot rolled coil inventories are down 8.2%. Coal inventories at China’s ports are also down 10.9%.

It is more difficult to construct wider inventory totals, but producer goods seem to have been falling steadily and consistently since 2008. That fall has moderated significantly over the last year, but still, by June, inventories of producer goods were down 7.5% yoy.  It is even more difficult to reconstruct an inventory series for durable goods generally, but my attempt suggests inventories of durable goods peaked in September 2014, have fallen 18% since then and were down 0.3%yoy in June.

This combination of falling import demand and falling inventory holdings of industrial commodities is consistent with what one would expect after a prolonged period of unusual monetary discipline. What would be consistent with a relaxation of that discipline would be, at the least, a willingness to stabilize inventory holdings, which with even steady underlying domestic demand, would result in a resumption of rising demand for industrial commodities. 

Which is perhaps what is also signalled by freight rates. The Baltic Dry index ended July at 1,131, up 50% yoy, and slightly more than double the Feb 2015 low.  Since the end of July, it has dropped to 1,014: the average price since 2011 is 1128, and the current price is 0.3SDs below that average.  Interpretation? The index was anticipating some pick-up in demand, and still is, although it now has slight doubts. Perhaps it too places its faith in Markit’s PMIs.

China Post-Dollar Policy - Coordination or Frustration?

With faultless timing, the BIS’s Financial Stability Board published its once-every-five-years peer review of China, assessing the authorities’ administrative ability to foresee, recognize and react in a timely manner to financial instability. Its message? That whilst great strides had been made, there are still a plethora of regulatory agencies with mandates sufficiently loosely drawn that their efforts sometime overlap and nullify each other.

Or, as they put it: ‘Enhancing inter-agency coordination and developing an integrated risk assessment framework will promote a common understanding of objectives and risks, which will in turn facilitate joint policy actions and public communication.’

Whilst the FSB was focussing on the agencies with a claim to oversee various parts of China’s proliferating financial sector, they could have extended their review to highlight the way the different agendas of the Ministry of Finance and PBOC have hampered effective monetary policy development in the run-up to the stockmarket collapse and subsequent yuan devaluation.

The tension between the two arises because government has 3.6tr yuan deposits with the central bank, amounting to 11% of its total assets, or, excluding fx reserves,  about a third of the implied domestic assets of PBOC. By raising or lowering those deposits, the Finance Ministry can affect private sector liquidity: when it lowers its deposits, it pumps money into the private sector; when it raises deposits, it takes money out of the private sector.

Over the last year, the average monthly movement of these deposits (addition or subtraction) has come to 373bn yuan.

During the same time period, the average monthly addition/subtraction to liquidity made by PBOC has been 85bn yuan. But open market activities are not the sum total of PBOC’s interactions with the domestic economy. We can estimate those by looking at the change in PBOC’s total assets, minus the change in the fx reserves kept on that balance sheet.  Currently, these implied domestic assets amount to 11.28tr yuan, and they increased by 2.71tr yuan, or by 32%, in the year to July, with the average monthly addition/subtraction coming to 418bn yuan.

As we can see, the Finance Ministry has a swing factor averaging 373bn yuan a month, and PBOC has a total swing factor of 418bn yuan.  Those are big numbers, and if deployed in a consistent and coherent way, they could have a serious impact on domestic liquidity.  But they are also so similar in size that they each separately could frustrate and cancel out each other’s policy intentions.

So what’s actually happening?  The following chart shows the 6m momentum change vs in government deposits and PBOC’s implied domestic assets, expressed in SDs vs historic seasonal trends.

And what it captures is that the default position over the last year has been for PBOC and Ministry of Finance actions to pretty much cancel each other out.  During the second half of 2014, as the dollar began to rise and China’s foreign exchange reserves began to fall, PBOC responded by rapidly expanding their domestic assets. This was a reasonable response to the tightening of conditions implied by the forced-march rise of the Rmb. But the impact was negated by the rise in government deposits made by the Finance Ministry - what PBOC put in, the Finance Ministry took out. 

Early this year, when it was clear that the economy was in worse shape than anticipated, the Finance Ministry abruptly changed its tactics, running down its deposits in PBOC, with the effect of pumping liquidity into the domestic economy.  Unfortunately, just at that time PBOC also changed its policy, cutting back sharply on the growth of domestic assets: 72% of the rise in domestic assets made in the year to July was made during between July 2014 and Jan 2015.  Result? Both policy initiatives were cancelled out once again. 

The hope is that, with monetary policy no longer constrained by the need to shadow the dollar, both PBOC and Finance Ministry can agree on coordinating a mutual approach to fiscal and monetary policy which can be sufficiently accommodating to make a positive impact on the economy. The data for July - the latest available - hints that something like this may yet emerge.

China Devalues - More Consequences

The government's reasons for launching the reform will decide the yuan's exchange rate in the future. If it's economic, then depreciation will continue because the dollar is expected to become stronger. If it's political, depreciation will not last.

- Xu Gao, chief economist of Everbright Securities

A lot hangs on that observation: a modest devaluation and/or sustained depreciation could help China’s economy a lot. A chaotic devaluation triggering capital flight and undermining the stability of the deposit base would be disastrous.

Whilst markets fret about the potential negative consequences of China’s devaluation, it is easy to forget that it does at least go some way towards correcting a major  policy mistake - the unwillingness to ease monetary policy in the latter part of 2014 to offset the tightening impact of keeping the Rmb effectively tied to the soaring dollar. July’s stockmarket collapse pointed very strongly to the need for a more dramatic about-turn in monetary policy than had previously been tolerated, and August’s devaluation, if nothing else, achieves that.

What is more, by releasing the de facto dollar peg, China in theory gains the freedom finally to operate a monetary policy which serves the cyclical needs of the domestic economy. And although China’s has a more positive inflationary dynamic than consensus is prepared to admit, there is no doubt that more accommodative monetary conditions stand the best chance of improving the purely cyclical economic dynamics.

So far this year, PBOC edged only half-heartedly towards loosening policy, which began to bear similarly modest fruit in May, June and July’s monetary data. In particular, July’s ‘surprisingly good’ money and credit data  - M2 up 13.3% yoy, new bank lending of Rmb 1.48tr - need substantial qualification The attempt to prop up the stockmarket inflated both bank lending and M2 growth whilst simultaneously diverting credit away from the ‘real economy’. (See this for explanation).  And the tepid loosening seen in May, June and July gets a substantial boost by from August’s devaluation.

Historically, where changes in China’s monetary conditions have led, domestic demand and industrial momentum have usually followed soon. Whilst July’s industrial momentum was weak to an extent which offset June’s relative strength, and July’s domestic demand data was just plain weak, in both cases,  the 6m momentum trendlines, although in negative territory, are inflecting up. It is a fair bet that this modest upward inflection will be maintained into August and probably beyond.

And in addition, prior to the devaluation we were already looking at a modestly rising CPI (and thus falling real interest rates).  Unless accompanied by destabilizing capital flight, the devaluation raises the likely inflation outlook, rather than depressing it into a possibly deflationary scenario.  (Nb, this is not the view of consensus, which is looking for inflation of 1.5% in 3Q, 1.8% in 4Q and a fairly steady 2% in 2016. Thus the 1.6% yoy rise in July’s CPI was not expected.

Even before the impact of Rmb devaluation is taken into account, those CPI forecasts look too low to me: I’d be looking at 1.8%-1.9% in 3Q15, 2.3%-2.6% in 4Q15, rising to 2.9%-3.4% in 1Q16 and 3%-3.7% in 2Q16.

But the improvement in China's monetary conditions will also have an impact on global monetary conditions. Indeed, it will accelerate an upward inflection point which had already arrived in June.

My monetary conditions indicator track what I believe to be the four key things one needs to know about an economy’s money: how much of it there is;  what happening to its domestic price;  what’s happening to its international prices; and what’s happening to its time-value. For my global monetary conditions indicator, I weight for the US, Eurozone, China and Japan according to 5yr dollar GDPs average.  The key thing to know is that conditions have been tightening since 2Q14, reaching their nadir in 2Q15, since when they have been in tentative recovery.  That recovery gathered pace in June and July, and China’s Rmb depreciation will almost certainly accelerate that recovery significantly in August.  More, during the early part of this year, monetary conditions were deteriorating in the US, China and even Japan, and easing only in the Eurozone.  By August, my estimate is that they will be improving in China, in the US and in Japan, whilst deteriorating slightly in the Eurozone.  Overall, however, the upward inflection point has already arrived.

China Devalues - Some Consequences

What Happened: People's Bank of China devalued the Rmb, setting the rate 1.9% lower on August 11, and a further 1.1% the next day - the biggest fall for the Rmb since the 33% devaluation in the first week of 1994, and seemingly an abandonment of prioritising early inclusion in the SDR over the needs of the domestic economy.

Why It Matters:  This is an important development both for China (its economy and politics), for the rest of Asia, and for the world economy.  Let's take them separately. For China, the decision to devalue marks the abandonment of two linked policy goals. First, and most obviously, it is an acknowledgement that the economic sacrifice made in demonstrating sufficient stability for the Rmb to be included in the SDR at an early date, is proving too burdensome.  Or, to be blunt, it acknowledges the error of allowing the Rmb to be dragged up with the dollar last year, without an aggressive easing in other areas of monetary policy.

Second, and less obviously, it marks the end of the carefully assembled illusion that sufficient foreign reserves and a sufficiently conservative set of banking policies could allow China to escape indefinitely from the monetary policy trilemma (the one which makes a fixed currency, open capital account and independent monetary policy an unstable triad).  Both of these mean that a serious policy re-think is now inescapable.

Politically for China, the stockmarket's fall followed by the predictable devaluation of the Rmb demonstrates two things: first, it tells the Party that it cannot control the Market; second, it tells the Chinese people that the Party cannot control the Market.  Given that the Party treasures control above all else, this represents a genuine political crisis.  So in short, this is a moment of profound challenge and, ultimately change, for China's political economy.

For Northeast Asia, the problem is very simple: China accounts for just over 70% of Northeast Asia's combined exports. If China is devaluing in order to maintain its export position (a subsidiary aim, with the principal aim being to raise utilization rates in an economy which has been driven by the growth of capital stock), then export prices will be cut for every other Northeast Asian trading partner and competitor. The deflation which so far has been largely confined to commodity markets, will spread more rapidly to Asian manufactures, starting now.  Within Northeast Asia, Japan is the most obviously vulnerable, having tried for two and a half years to ginger up its economy via devaluation. China has just trumped that strategy.

For the rest of the world, there is the uncomfortable fact that in dollar terms, during the five years to 2014, China accounted for 54% of the total growth in GDP for the G7 and BRICs combined.  Or put it another way, between 2010 and 2014, China's dollar GDP grew 71.5%, whilst the rest of the G7 and BRICs expanded just 9.8%.  Depending on how far China ends up devaluing, those numbers are going to change, and quite possibly dramatically.

And finally, and again obviously, China's devaluation is likely to trigger a whole new round of Asian-sourced deflation in the traded goods sector. Bond markets have made their initial reaction, western monetary policymakers will be re-casting their sums.

What Happens Next?   
We shall see. At present, Chinese sources are glossing the devaluation merely as an extension of China liberalizing its economy. Whilst one can't rule out completely that the end-result may yet be that, it defies belief that this is the motivation. Rather, for the reasons given above, this is a moment of profound challenge for China's policymakers, and how the various tensions, problems and opportunities will play out is, for now, anybody's guess.