Fallouts from the Chinese Yuan Devaluation

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Chinese currency devaluation, explained

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This week the Chinese government has allowed its currency, the yuan, to decline in value by about 4 percent against the US dollar. The move has renewed a long-simmering debate about China’s exchange rate and whether a cheap yuan will be harmful to the US economy.

In the wake of the 2008 financial crisis, critics faulted the Chinese government for intervening in the market to make its currency artificially cheap. A cheap yuan gave Chinese exporters an advantage in world markets, which critics said was harming US businesses.

Today, the situation is different in an important respect: The Chinese economy is weak while the US economy is strong, which is exerting downward pressure on the yuan. That means China doesn’t have to intervene to make its currency cheaper — it can just let market forces push the yuan down.

At the same time, the healthier US economy makes it easier for the US Federal Reserve to counter the harmful effects of a cheap yuan on US exports. So while there were good reasons for Americans to worry about a cheap yuan a few years ago, there’s less reason to be concerned today.

I asked Joseph Gagnon, an expert on international economics at the Peterson Institute for International Economics, to help me understand what’s happening in China. Here’s what I learned.

Currency devaluation is like a nationwide sale

You can think of currency devaluation as a kind of nationwide sale. There are thousands of businesses in China that sell goods and services to customers in foreign countries like the United States. Their goods are generally priced in China’s own currency, the yuan. So if the yuan becomes less valuable relative to the dollar, Chinese imports suddenly become cheaper here in America. In other words, when the yuan falls by 4 percent, as it has over the past few days, it’s as if every business in China cut its prices for Americans by 4 percent.

And just as sales help stores sell more of their products, a currency devaluation helps countries sell more exports, boosting the economy. Right now the Chinese economy is in the midst of an economic slowdown and has suffered from stock market turmoil, so it can use some extra help.

Chinese devaluation is bad for US exports

Of course, everything I’ve just said works in reverse for the United States. As the yuan gets cheaper from the perspective of American consumers, the dollar gets more expensive from the perspective of Chinese consumers. That means it’s getting more expensive for Chinese people to import American-made goods, so they’re likely to import fewer of them. Lower demand for US goods could mean slightly slower economic growth here in the US. (And the same, of course, is true of other countries whose currencies are gaining value relative to the yuan.)

It’s as if every business in China cut its prices for Americans by 4 percent

For this reason, people often treat currency devaluation as a “win” for the devaluing country and a “loss” for the country whose currency gets more valuable. That’s why Chinese officials have had to defend themselves against criticism from abroad — people outside China worry that further declines in the yuan could weaken economic growth outside of China.

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But it’s important not to forget that the first-order result of a cheaper yuan is that American consumers pay lower prices for Chinese goods. That’s good for American consumers. So if the Fed can offset the negative macroeconomic effects (which it probably can right now — more on that below), a cheap yuan could be good for Americans overall.

China’s government used to make its currency artificially cheap, but things are different this time

Most developed countries, including the United States, allow the market to set the value of their currency. US policies can affect the value of the dollar indirectly, of course, but day-to-day fluctuations in the dollar’s value are determined by supply and demand for dollars, not by the US government.

China has taken a different approach. Until 2005, the government kept its currency pegged to the dollar, with the central bank buying or selling currency as necessary to ensure that one dollar was worth around 8.2 yuan. Since 2005, the currency has been pegged to a basket of currencies, and the exchange rate has changed over time, but China still actively manages the currency’s value on a day-to-day basis.

For much of the past decade, China faced accusations that it was using its control over the currency to make Chinese exports artificially cheap. Especially in the years after the 2008 financial crisis, US critics accused China of using control over its currency to give Chinese companies an unfair advantage over US companies. That was a big deal because in the depths of the recession, US businesses needed all the customers they could get.

No one expects China to let go of the leash altogether

But things have changed. Over the past five years, the US economy has been getting stronger, pushing up the value of the US dollar. Meanwhile, the Chinese economy has been getting weaker. The result: The Chinese government no longer needs to intervene in the market to get a cheaper yuan — and the export boost that comes with it. It simply needs to relax its control over the currency and let market forces push its value down.

Still, Gagnon stresses that “the People’s Bank of China has complete control over what happens to their currency.” If the government had wanted to prevent the yuan from falling, it could have used its vast currency reserves to accomplish that. It chose not to.

China is slowly moving toward flexible exchange rates

In the long run, China hopes to emulate developed economies with fully flexible exchange rates. That’s an essential precondition if the yuan is ever to challenge the dollar as the world’s reserve currency. However, China has been moving slowly.

“It’s like having your dog on a leash,” Gagnon says. “Think of a flexible exchange rate as you cut the leash. China’s version of it is, ‘We’ll let another 6 inches of leash out, but it’s still on a leash.'”

So while this week’s devaluation is a step toward greater flexibility, no one expects China to let go of the leash altogether. If exchange rates move too far in a direction the Chinese government doesn’t like, the Chinese central bank will intervene.

A cheap yuan strengthens the case for the Fed to keep rates low

Jewel Samad/AFP/Getty Images

(Jewel Samad/AFP/Getty Images)

It’s the job of the US Federal Reserve to manage monetary policy in a way that provides adequate demand for US companies. The Fed was struggling to do that in 2009. The Fed cut interest rates to zero and took other extraordinary measures — and the economy still performed poorly. In that environment, there was reason to worry that a cheap yuan was contributing to America’s economic slump.

But the situation is a lot different today. The economy has been expanding for several years. Indeed, things are going so well that the Fed has stopped debating how to stimulate the economy, and is instead debating how quickly to tighten monetary policy. The central bank ended its aggressive “quantitative easing” policy last year, and is widely expected to begin raising interest rates in the coming months.

This means the Fed is in a much better position to offset the effects of a cheap yuan than it was five or six years ago. If the Fed is worried that weak exports will hurt the US economy, it could delay an interest rate increase that is widely expected to occur later this year.

Gagnon believes the cheaper yuan is “perhaps something the Fed should take into consideration to delay a rate rise.”

The weak yuan will change the debate over currency manipulation

The fact that the yuan’s current decline is driven by market forces instead of Chinese intervention will also scramble the debate over Chinese currency manipulation. For years, people have been pressuring the Obama administration to fight China’s cheap-yuan policy. But the Chinese government doesn’t have a cheap-yuan policy anymore — if anything, the Chinese government may be intervening to prevent the yuan from falling even further.

China has always been a convenient villain for US currency hawks

Of course, that doesn’t prove that currency manipulation isn’t a problem. Other countries manipulate their currencies, and China might go back to making its currency artificially cheap in the future. Groups that have faulted President Obama for failing to get currency manipulation rules in the Trans-Pacific Partnership deal will probably continue advocating such rules.

But China has always been a convenient villain for US currency hawks. Now that the country has stopped pushing down the value of its currency — at least temporarily — critics’ arguments will lose a lot of their bite.

Chinese developers to suffer little from yuan devaluation – S&P

HONG KONG (Reuters) – Standard & Poor’s said on Friday the magnitude of yuan devaluation is not significant enough to cause a deterioration in the credit profile of Chinese property developers, as it expects the currency to depreciate only by a low single digit.

China’s central bank devalued the yuan in a surprise move on Tuesday, driving the currency to a 4-year low and raising concerns over a spike in financing costs for developers with high overseas debt ratios. The Chinese currency has lost some 3.1 percent since Tuesday.

Analysts said around 40 percent of developers’ total debts were denominated in U.S. or Hong Kong dollars as of the end of 2020, with China Overseas Land & Investment (HK: 0688 ) and China Resources Land ‘s (HK: 1109 ) ratios at more than 70 percent.

“Debt servicing will be more costly, but developers will not really suffer that much. Those with higher offshore debt exposure are also the stronger players in the sector and they have enough buffer, so there won’t be a big impact on their credit profile,” S&P’s corporate ratings senior director Christopher Yip told a telephone conference.

Yip said increasing issuance in the onshore corporate bond market will help to alleviate some pressure on funding costs.

S&P on Friday raised its forecast on China’s property sales growth to 5 to 10 percent on expectations the sector will continue to recover, supported by stimulus policies.

The rating agency also revised up growth expectations on home average selling prices to flat to 5 percent in the next six to 12 months, on improved home buyer confidence. The forecast on both sales and prices were both down 5 percent to flat previously.

What the yuan devaluation means around the world

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For the second day in a row, China has cut the value of its currency, the yuan.

Stock markets have been rattled, and with China a major exporter, buyer of commodities and having a huge consumer market, it will not just be investors who feel the impact.

Our correspondents around the world consider what the devaluation means where they are.

Africa, by Lerato Mbele, BBC Africa Business Report

China is now the number one trading partner for most African countries.

In an effort to make the buying and selling of goods much easier, some states introduced the yuan into their foreign exchange system.

In 2020, the Nigerian Central Bank pledged to store between 5%-10% of its foreign reserves in yuan, alongside dollars and euros.

At the time, the Chinese economy had the highest growth rates in the world.

Nigeria believed that looking east would help protect the local currency, the naira, against the volatility of oil prices set in dollars.

Later on Kenya, whose port is a major gateway for Chinese goods, announced plans to set up a clearing house for the Chinese currency.

It was hoped that at the port of entry, Chinese clients selling manufactured goods could pay excise and taxes, and get their goods into the local economy speedily.

The immediate impact of the devaluation of the yuan cannot be seen or measured, but countries that have taken steps to transact in Chinese money could see pressure on their own local currencies.

In general, other African nations have limited exposure, because they still price their goods in American dollars.

Nonetheless, as China is now their biggest customer, they could feel the pinch indirectly.

If the yuan is devalued, buying anything priced in dollars becomes more pricey for the Chinese.

Therefore the sale of commodities such as platinum, copper or coal may become more expensive, which could reduce demand.

So while there is no immediate impact, in the medium- to long-term, the sales of African commodities and African currencies could take a knock.

Brazil, by Daniel Gallas, BBC South America Business Correspondent

Under normal circumstances, the devaluation of the yuan would have a huge, negative impact on the Brazilian economy.

China is Brazil’s main commercial partner, and a weaker yuan would mean a Brazilian loss in its terms of trade with the Asian giant.

But these are not normal circumstances in Brazil, as the country is facing its worst economic downturn in two decades.

One of the few positive side-effects of this is that the Brazilian real has dropped to its lowest level in 12 years, favouring Brazilian exports abroad.

While the Chinese currency has dropped about 3% since January, the Brazilian real has lost 23% of its value.

If this were a purposeful currency war, Brazil would surely be “winning” in the race to the bottom.

Brazil’s economy is in crisis largely due to China, but this has more to do with the overall slowdown of the Asian economy and the end of the commodities boom cycle in recent years than just currency fluctuations.

India, by Yogita Limaye, BBC India Business Report

Not far from our office in Mumbai, there is a big street market with rows and rows of little shops that sell a wide variety of shoes at very low prices. Some pairs cost as little as $4. All of them come from China, and that’s not it.

India imports heavily from its eastern neighbour. The bill is $60bn (£38.4bn). The devaluation of the yuan will mean that companies which buy from Beijing will now have to spend a little less.

Firms that make electrical and electronic goods in India import a bulk of their components from China, so they are going to be happy.

Most analysts though, do not expect them to pass on that benefit to consumers here.

But there are several sectors where India competes with China to sell to the world.

Textile manufacturers and chemical producers might have it a little tougher now because in the global marketplace their goods might become less attractive than those from China.

This could be a problem for the economy as a whole because Indian exports have been contracting for seven months in a row already, so another dip might further affect the country’s trade balance.

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