Why China’s stock market crash is so bad for Apple

China’s stock market has been crashing this summer, which is both a sign of and potentially a cause of underlying economic problems in the country. Those problems have also led to a reduction in the value of China’s currency. This instability has roiled global financial markets more generally, but Apple — America’s largest company — has been hit especially hard, losing 18 percent of its value over the past six months and wiping out many tens of billions of dollars of paper wealth.

The situation got so bad that Apple CEO Tim Cook recently took the extraordinary step of emailing CNBC anchor Jim Cramer to try to intervene in the stock slide, assuring investors that “growth in iPhone activations has actually accelerated over the past few weeks, and we have had the best performance of the year for the App Store in China during the last 2 weeks.” The reassurance did at least some good in halting the slide, though Apple shares are still far from making up their losses.

Apple has an unusually heavy exposure to problems in the Chinese economy for reasons that aren’t addressed by Cook’s letter.

The basic issue is that Apple doesn’t like to change its retail prices in response to currency fluctuations. So when a foreign currency declines in value relative to the dollar, the number of dollars Apple earns per sale goes down. Conversely, foreign currency appreciation means Apple is earning more dollars.

Last quarter, 27 percent of all Apple’s revenue came from Greater China. More importantly, more than 50 percent of Apple’s revenue growth came from China.

Even if Apple’s sales — in terms of number of units — hold up, the value of those sales is going to decline at a time when the company was counting on rapid growth to help offset the essentially inevitable slowdown of iPhone sales in the already highly saturated US market.

Apple rather famously relies on Chinese suppliers and assembly facilities, so you might think a falling yuan would saving Apple money. But most of Apple’s key contracts with suppliers like Foxconn and Lenovo are denominated in dollars, meaning the suppliers themselves may see a benefit from lower costs but Apple will not.

So Apple is paying Chinese companies dollars to assemble phones that are then sold to Chinese consumers for yuan. When the value of the yuan goes down relative to the dollar, that’s not going to be good for Apple’s profits.

Oftentimes large companies that are exposed to different kinds of currency risk will try to hedge that risk by buying derivatives. For example, if a more expensive Japanese yen is good for Apple’s profitability but a cheaper yen is bad, a company might offset that by placing a speculative bet that the yen will decline in value. That way, any yen-specific changes will be offset, and the success of Apple’s Japan operation will be driven by how much Japanese people like iPhones.

The problem is that China’s tightly regulated financial markets make hedging difficult and at times expensive.

This seems to be one of the reasons Apple is borrowing a huge number of Australian dollars. Australia exports enormous quantities of raw material to China, so bad economic news from China tends to lead to a declining price of Australian dollars. So-called kangaroo bonds are thus a kind of back-door hedge against Chinese currency risk. But even the best hedging strategy can’t bring back the kind of staggering growth opportunity that led to Apple’s China revenue more than doubling over the past year.

You’ve probably heard a lot about trade with China over the years, but it’s important to understand that Apple is fairly unusual in terms of relying heavily on Chinese customers. The United States as a whole sells way more stuff to Canada and Mexico than to China and lots of prominent technology companies in particular — Google, Facebook, Twitter — barely even exist in China due to censorship.

But America does buy lots of stuff that is made in China, and while Apple’s supplier contracts are structured in a way that doesn’t let them take advantage of lower production costs, that’s not true for every company. Apple isn’t alone in the China boat — airplane manufacturer Boeing is also exposed to the Chinese economy, though its sales are priced in dollars — but it’s not a very crowded ship.