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.

HKMA's "3rd-country" yuan shows the value of China's currency versus those of its trade rivals in world markets. http://t.co/HjtuONKSa1—
Simon James Cox (@s1moncox) August 11, 2015

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”.

Comment

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.