How China Affects American Markets

China Exchange Rate

China’s financial markets have been making headlines recently, and generally not in flattering ways. First its bubbly stock market soared and subsequently crashed. Then concerns spread about the country’s slowing economic growth. This week the country’s central bank reduced the value of its currency, the yuan. How much will these events affect financial markets in the US?

At first glance the effects on the US should be mild. Though China is the world’s second-largest economy, its financial markets are not a commensurate size. It makes up less than 3% of the MSCI ACWI, an index representing the global stock market. Only about 2% of large US companies’ revenue comes from China. And as of last year less than 1% of global currency transactions involved yuan.

The most recent upheaval—the decline in the value of the yuan—wasn’t even particularly large. The currency fell by a few percentage points against the US dollar over the course of two days. While such a move is unusual for the yuan (which the Chinese government keeps loosely pegged to the dollar) it pales in comparison to other currency movements. Russia’s ruble, for example, fell by more than 30% against the dollar in a single month at the end of 2014. And the US Dollar Index, which measures the value of the dollar against a handful of other currencies, has risen during the past year, meaning that the yuan is still far worth more compared to most currencies than it was 12 months ago.

China’s financial market turmoil could still end up having a sizable adverse effect on the US, but only to the extent that it may signal more bad news to come. The decision to let the value of the currency decline, for example, could indicate that the economy is doing worse than publicly-released data suggests. It’s also possible that the currency devaluation was just the first step in longer-term effort to try to boost the Chinese economy by weakening the yuan. Such a shift could cause both economic and political trouble in the US.