China joins the Currency Wars as it devalues

One of the themes of this website has been that with other types of monetary policy being increasingly ineffective that exchange-rates have moved to the front of the pack. We have seen interest-rates cut to and sometimes below what was previously considered to be the lower bound but if such efforts were as effective as claimed we would not be where we are. Also I am reminded of the fact I noted yesterday which is that all 15 OECD countries which have raised interest-rates post credit crunch have since cut them! All sorts of extraordinary monetary policies have also been tried in some cases in the billions, in others in the trillions. However countries have increasingly tried to gain a relative advantage by lowering their exchange rate leading to this from Brazil’s Finance Minister back in September 2010.

We’re in the midst of an international currency war…This threatens us because it takes away our competitiveness.

The advanced countries are seeking to devalue their currencies.

Hence the Currency Wars theme which has seen an opening salvo fired this morning into the Pacific and perhaps the South China Sea.

China Devalues

Here is the statement for the People’s Bank of China or PBOC

Effective from 11 August 2015,the quotes of central parity that market makers report to the CFETS daily before market opens should refer to the closing rate of the inter-bank foreign exchange market on the previous day, in conjunction with demand and supply condition in the foreign exchange market and exchange rate movement of the major currencies.

It is a rather unwieldy statement to say the least! So this is what happened next according to Bloomberg.

The bank then weakened the midpoint to 6.2298 per dollar on Tuesday morning, compared with Monday’s 6.1162 fix – the biggest-ever one-day adjustment to the midpoint.

I note that Bloomberg has concerns over what this might mean going forwards.

Under the new method, market forces would have more ability to take the yuan lower in the weeks ahead,

As an aside there was for a while a fashion for calling the Chinese currency the Renminbi whereas the Yuan seems to have returned to some extent. So we have a lower currency and a new perspective from China.

Wasn’t it supposed to be appreciating?

This section is along the lines of this from Blueboy.

Remember me?

Let us go back to June 21st 2010.

the People´s Bank of China has decided to proceed further with reform of the renminbi (Yuan) exchange rate regime and to enhance the renminbi (Yuan) exchange rate flexibility.

Even for central bankers they are euphemistic! The Chinese currency was going to be allowed to rise against the US Dollar in response to arguments like this.

For those who do not follow the situation closely it has been considered for a while internationally and by the US administration that the Chinese Yuan is undervalued (estimates vary between 25 and 40%) and that this is one of the reasons for China’s Balance of Payments surplus and  a contributor to the American deficit.

Back then some 6.83 Yuan purchased a US Dollar and after today’s move to 6.23 we see that the total appreciation was just under 9% or nowhere near enough to correct the claimed undervaluation. However we need to think wider as the US Dollar has been rising meaning that an ever-growing list of currencies are undervalued against it. In May the Peterson Institute crunched the numbers resulting in this covering the year to April.

The most important changes were the large effective appreciations by the US dollar (about 12 percent) and the Chinese yuan (about 12 percent),

So we now find ourselves on a road where the Chinese currency is no longer undervalued and in fact on its way to correcting this has put a squeeze on the economy. If we switch to comparing it with its neighbours we see this.

Now we have rather a different perspective which is that China has been seeing a currency appreciation especially against its trading competitors as shown by the rise of the yellow line in that chart. Back in January 2014 FT Alphaville quoted this from Lombard Street Research.

But the situation now differs because the currency has become overvalued since 2011. The rebalancing from investment towards consumption given the overvalued yuan would be made easier if the currency is allowed to depreciate as capital flows are liberalised fully.

To put it another way China could not cope with the level of its exchange rate and there was trouble ahead. Since then the slow down in its economy has backed that up and now perhaps we are seeing an official response.

The currency devaluers

Another way of putting this is that devaluing or depreciating your currency is called exporting deflation. Now let us return to the Peterson data quoted earlier and see what it tells us about that.

and the large effective depreciations of the euro (about 11 percent) and the yen (about 8 percent).

If we take that a step further we see that two large currency blocs are devaluing from a position of strength in trading terms. The Euro area has a consistent current account surplus and whilst in recent times energy imports have pressurised Japan on this front it is hardly a serial deficit nation! So we are left with the thought that they and in particular Japan have exported deflation to China. When Abenomics turned Japan into a currency depreciation some 12.4 Yen bought one Yuan whereas this morning it took 20 of them. Quite a change is it not? It matters as the two countries trade together on a large scale.

Exports (referred to as China’s imports from Japan hereafter) increased by 0.3% to US$162.7 billion and imports also rose by 0.1% to US$181.0 billion. (Jetro).

Added to this is the fact that they will have more than a few industries that compete with each other for business around the world. So for China the plunge in the Yen caused by the policies of Abenomics have been a large issue and may well have been the straw which broke the camel’s back.

The International Monetary Fund

This has its own unit of currency called Special Drawing Rights or SDRs. These are based on the US Dollar, Euro, Yen and UK Pound £. An obvious issue is why not have China’s currency too and here are the thoughts of the IMF from last week.

The Chinese renminbi (RMB) is the only currency not currently in the SDR basket that meets the export criterion. Therefore, a key focus of the current review will be whether the RMB also meets the freely usable criterion in order to be included in the SDR basket.

There is much to consider here not the least that two of the current four ( Euro area and Japan) are indulging in large-scale Quantitative Easing operations to reduce the value of their currencies. Unless the basket is extended the UK may well find itself demoted.

For now the issue over the Chinese currency is the fact that it is plainly not “freely usable”.


It seems that a new front has been opened up in the currency wars campaign. The Chinese authorities will know that they have sent a signal here to the rest of the world and that there will be concerns that they are a new kid in town.

There’s talk on the street; it sounds so familiar
Great expectations, everybody’s watching you
People you meet, they all seem to know you
Even your old friends treat you like you’re something new

If we look at the recent signals from the Chinese economy we know that a depreciation of just under 2% is far shy of what might reverse that. So we see a potential game of pass the exporting deflation parcel where Japan has been joined by Euro land and China responds. Now who thinks that the UK and US will respond to that with interest-rate rises?

Meanwhile in a land down under christened on here as the South China Territories there must be real concerns about what is going on and how much they will be sucked into it. From Bloomberg.

The Australian dollar lost 1 percent against the dollar on China’s devaluation,

As to whether this will solve the problem the aptly and presciently named China Crisis have some thoughts.

And if I wish to comfort the fall
It’s just wishful thinking

After all unless there are Martians it is all a zero sum game.


11 thoughts on “China joins the Currency Wars as it devalues

  1. Hi Shaun

    It seems to me that the Chinese are between a rock and a hard place. On the one hand the economic expansion has created a new and wealthy middle class and elite that is wondering when it will get political power and, on the other, a rural population sucked into the cities with new jobs and a new way of living which, if disappointed, may result in widespread civil insurrection.

    The Chinese, although not a democracy, are not dumb and I’m sure they see the considerable political dangers of reduced growth – the wealthy becoming less wealthy and the poor becoming hungry so its clear why they have taken this step.

    As you say it is likely to result in a flood of deflation coming to the West and must result in a severe knock to IR rises here and elsewhere. Which is worse for the western economies – inflation or deflation? The CBs obviously think it’s deflation and I would think that this move by the Chinese is a much more serious harbinger of “real” deflation than the faux and temporary view of deflation that followed the recent dive in the oil price.

    I would suspect that it would only take a couple of years of zero or negative inflation to seriously impact on the fiscal position of governments, firms and individuals in the West and this will simply compound the difficulties we are already in.

    • Hi Bob J

      I agree that the fear of deflation has been whipped up by central banks who are worried about the implications for the various debt burdens. Back in 2008/09 the Bank of England panicked in the face of fears of disinflation (false) and deflation and that is one of the reasons we got inflation. I didn’t notice that in the valedictory inteview given by David Miles yesterday!

      So we learn that to coin a phrase central banks will do “whatever it takes” when they fear genuine deflation. As you say there are ever more fears of deflation coming from China and I note that yesterdays oil price bounce now looks like a dead cat bounce.

      It is the road on which we could get inflation and in the worst case hyperinflation as the two polar extremes are not so polar in a true crisis.

  2. So currency wars are hotting up, and we are about to increase interest rates “sooner rather than later”. Just as well BofE left rates where they were. Would not want to be an exporter to China at the moment!
    What price popcorn futures?

    • Hi Foxy

      I noted earlier someone tweeting a list of the top 20 technology exporters to China and I think we know what point they were intending to make! The last old style Bank of England Minutes said that Greece had put members off voting for a Bank Rate rise. Will China be the new Greece?

      After all it is a much bigger deal in world terms. As to corn futures they have followed other commodities and dropped 3% today. Although of course Starbucks has proved that commodity price falls do not necessarily mean product price reductions.

  3. It’s a race to nowhere as far as I can see, where this is all going to lead is anyone’s guess. Is it reasonable to think this move was presaged by the Swedish Rijksbank holding negative rates? Get you digs in early folks!

    On the musical front it puts me in mind of Yello’s classic, The Race:

    Count on me I’m gonna win the race
    Room-dah-bee-boom the whippering dong

    Now shut the door keep down to south

    Not any track is turning but the race is in my head
    I’m attacking the illusion but the stopping drives me mad

    Time is running out and the illusion fades away
    Time is running out another day is on it’s way

    Another sun was shining and he knew he wasn’t great
    He didn’t ever talk about he knew he couldn’t wait

    Are you ever gonna push me let me run and let me do?
    I need it and I’m ready and I haven’t got a clue

    Fire away
    This is the race

    Give me the race

    • Hi Andy Z

      Was this what the Riksbank and others have been fearing? I am a little unclear how a house price bubble goes with China exporting some deflation but it may well turn out to be a case of watch this space! As to Janet Yellen and Mark Carney there is much to ponder.

      I haven’t seen a mention of Yello for ages 🙂

      • Hi Shaun, re Sweden I was just pondering that the currency race to the bottom can badly affect the minnows as well as the bigger fish. So I just wondered, maybe in amongst all the guff and bluster from the Rijksbank, the real reason for the negative rates was as an insurance/hedge against the actions of others?

  4. Hi Shaun,
    Thanks for an interesting post as always. Forward guidance has had an unintended consequence in that re-mortgages are surging as borrowers look to take advantage of rates before the promised rate hike. Perhaps the re-mortgagers are jumping the gun and instead would be better waiting for the next cut!

    • Hi Zummerzetman

      The concept of Forward Guidance always relied on the abilities of those giving it. That has already misfired on several counts starting with the use of a 7% unemployment rate in the UK! Those of a more cynical bent might wonder if the Bank of England has operated to the benefit of the banks one more time with its Bank Rate rise hints and promises.

  5. Hi Shaun,
    China’s manufacturing is currently in recession whilst services continue growing:

    The Yuan seems to have been pretty much pegged to the dollar for the last few months and as the dollar appreciated so did the Yuan. As Chinese manufacturers are sensitive to FX we may have the explanation to the graph above.

    Then the IMF say they want to delay China joining the currency basket re SDR, then China decouple from the dollar.

    They nay have pegged to the dollar in the hopes of it strengthening their cause to join the SDR but they’re told to wait until 2016 whilst the Fed limbers up for takeoff on interest rate policy with the consequent effects on the Yuan if China maintains it’s dollar peg. Meanwhile, China is already faced with this appreciation against the mexican peso:

    As Mexico is a competitor of China then, when faced with that set of facts and probably hearing murmurings from manufacturers talking about maybe building factories in Mexico and other competitor countries against whose currencies the Yuan has appreciated, it looks to me like the Chinese had no choice and they have been forced into this move.

    • Hi Noo2and thanks for the links.

      The Chinese must have seen the rise of the US Dollar with alarm as the peg dragged the Yuan higher. I bet they are not fans of Janet Yellen’s tactics! Mind you if you do peg your currency then it is one of the risks.

      As to your point about manufacturing then a 2% move is not consequential so we can expect (quite a bit ) more as time goes by as manufacturing will need a lot more than this to become competitive again. This of course moves us back to my question of who wants their currency to appreciate? The US and UK have been in that camp over the past year or two but neither will be keen on another push higher.

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