China's reaction to Brexit has already put the entire world at risk

The entire world is hysterical about Brexit, the UK’s decision to leave the European Union last week. Markets around the world are puking, people within the country are shocked, and people outside the country are wondering if there’s any way to take this back.

China has been no different.

At the highest level of Chinese government, the reaction to Brexit has been negative and dangerous, both in word and in deed.

“Against the backdrop of globalization, it’s impossible for each country to talk about its own development discarding the world economic environment,” said Chinese Premier Li Keqiang at a World Economic Forum meeting on Monday.

He said that the move increased uncertainty around the world. And as the leader of a country that’s finally finding some economic stability after a brutal first few months of the year, uncertainty the last thing Li needs.

Dirty deeds

On Monday The People’s Bank of China devalued the yuan by the most since August, a sign that the government is concerned that global economic growth will be hampered by the UK’s decision.

Of course it’s not alone in that thought. Barclay’s believes Brexit will burn 0.10% off Chinese GDP in 2016 and 2017. It will be “manageable,” but it won’t be easy.

But that’s not the part that could send traders into a cold terror flashback to February. It’s the yuan. Barclay’s thinks the currency could fall another 10% against the dollar before all this volatility is said and done, “given expected strong safe-haven flows” as investors search for stable places to put their money.

That means yuan-holders will want to take their money out of the country.

You see, for the past year China’s currency has been anything but stable. The government shocked markets with big a devaluation last August, and massive capital flows followed for two months. Those calmed, and then resumed again as the yuan fell at the end of 2015/beginning of 2016.

These outflows were the very thing that set markets careening down earlier this year. It was just an incredible volume of money flowing out of China. The government seemed to plug the hole in March, and things have been ok (a few hiccups aside) up until now, but the fear is that Brexit could change all of that.

In May, Goldman Sachs/Gao Hua economist Song Yu told Bloomberg that the calm that the yuan was experiencing was a “temporary sweet spot,” capital controls would not hold outflows back forever.

“But this is very much like a game of a cat trying to catch the rats,” he said. “Whenever the government manages to block a hole through which capital leaks out, people can always dig another hole to bring the money out over time.”

So you can see how this is a problem.

Done dirt cheap

The op-ed pages in China’s state media were more ferocious about the matter over the weekend. The Global Times
, a popular news tabloid, said that “Britons are already showing a losing mind-set. They may become citizens of a nation that prefers to shut itself from the outside world.”
More from The Global Times:

The Leave advocates had been calculating whether their pensions were guaranteed or migrants were encroaching on their neighbourhood. Bigger topics such as the country’s aspirations or its global strategy were overlooked.

Britain has been a special member of the EU. It has not joined the eurozone, nor adopted the Schengen agreement. France and Germany have been resentful of Britain’s half-hearted presence in the EU. In a sense, Britain’s exit may be a relief for both sides.

However, such relief is in effect a major setback for European integration. Such setbacks don’t happen in good times. Britain’s exit reflects the general decline of Europe.

There is reason for this anger that goes beyond near or medium term currency volatility too. What the UK has decided to do will likely make China’s biggest long term economic problem (overcapacity — having too may goods to sell that no one seems to want) harder to solve.

The UK is one of China’s top three trading partners. It needs the UK to buy as many of the goods that China has too much of as possible. If demand is hampered in the UK, that’s not going to happen. China needs the global economy as strong as it can be, and the UK just gave it a roundhouse kick to the face.

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