On the 11st August, the People’s Bank of China devalued its currency by setting the daily fix 1.9 % lower, sparking the biggest fall since 1994.This raises the question of what the central bank was hoping to achieve. The most popular explanation is that it wants to stimulate its sluggish economy by cheapening its currency. The depreciation, after all, came just a couple of days after a surprisingly big drop in exports.
China’s official version for this move states that is merely an adjustment to the way the currency is valued. However, some experts believe it could be an attempt to stimulate China’s economy, which has slowed down. The slowing economy is an obvious catalyst. In the first and second quarters China’s economy grew at an annual rate of 7%, the slowest pace in 6 years. Data shows that exports plummeted 8,3% year-on-year in July, far worse than expectations for a 1,5 % decline.
How this devaluation will help China?
A weaker currency should help make Chinese exports more competitive. It will make exports, which had been flagging, cheaper.
Is there another motive for such a devaluation?
Some believe it is part of China’s campaign to be considered one of the International Monetary Fund’s reserve currencies, an elite group of currencies including Sterling and the Dollar that the IMF uses for its loans.
Being one of the IMF’s Special Drawing Rights baskets of currencies is a mark of importance.
What difference will it make for the rest of the world?
China’s currency devaluation may be seen as a distress signal from Beijing policymakers, in which case the world’s second-largest economy may be far weaker than the 7% a year growth that official figures suggests.
If it is economy really is much weaker, it would be alarming for any company hoping to export to China.
Consequences on the Global Economy
- First of all, cheaper gasoline at the pump. China’s apparently insatiable demand for natural resources has been a key factor supporting the price of oil in recent years. If China’s economy is in trouble, which tends to undermine oil prices, probably means cheaper oil. Moreover, in coming months, weak Chinese demand could force down the cost of many commodities, from oil to iron ore. Brief periods of falling prices, particularly if concentrated among one or two commodities, can be good news. Nevertheless, economist warn about periods of persistently falling prices, which can undermine spending and investment, because consumers and businesses delay spending, expecting goods to be even cheaper in future.
- Bad news for Australia. Australia has experienced an impressive economic boom in recent years, on the back of selling natural resources, including coal and iron ore, to its Asian neighbours, and China accounts for more than a quarter of its exports. Other suggested hard-hit countries could include Brazil, Russia, Chile and Korea.
- Worse news for Greece. If the Chinese devaluation does bring a tidal wave of deflation to the global economy, the most vulnerable countries will be those that are heavily in debt, because while salaries and profits fall in a deflationary period, the value of debts remains fixed, making them harder to service. Greece is already suffering deflation after repeated cuts in wages and benefits as the government tries to balance the books, and if it worsens, it will only make its debts bigger.
- What about the US? The US is negotiating an important trade agreement, the Trans-Pacific Partnership, with a number of China’s rivals, including Japan. If Beijing allows the Yuan to decline further in coming months, it could increase trade tensions, or even a ·currency war”, between the world’s big trading blocs, to seize the largest possible share of global consumer demand.
- Negative consequences in Stock Markets. China has been trying to create a shift from export-led growth to an expansion based on consumer spending, while simultaneously trying to deflate a property bubble, taking into account that Chinese salaries have been rising, making its products less competitive. Growth is vacillating despite heavy pressure on state-owned banks to lend money readily to companies willing to invest in new factories and equipment, and despite of government spending on high-speed rail lines and other infrastructure projects.This fall of growth is having negative consequences in Chinese domestic consumption, which damages the whole system. For instance, weeks ago, the China Association of Automobile Manufacturers announced that nationwide care sales fell 7% last month, compared with a year ago. This is having a negative impact in Shanghai and Shenzhen stock markets, with harmful reverberations in all world stock markets as we are seen these last days.
In conclusion, if China really is trying to drive down its currency in any meaningful way to gain trade advantage, the world faces a dangerous moment. Such behaviour would send a deflationary shock through a global economy, already recovering from near recession.