The surprise move by the People’s Bank of China (PBOC) to weaken the Chinese yuan by nearly two percent against the U.S. dollar on August 11th was met globally with shock. Red ink was flowing on Wall Street and on stock markets worldwide. The effects are sure to hit Main Street in the coming weeks and months. Why did the PBOC act now?

The yuan has been pegged to the dollar with varying degrees of float for virtually the entirety of its existence. The exchange rate has been used as a tool, or weapon in the view of some, to vault the Chinese economy to the fore of global trade, rivaling those of the Eurozone and the United States in terms of nominal size. The PBOC achieved the exchange rate stability they sought, at least against the U.S. dollar, as evidenced by the chart below with data compiled from Oanda.com.

To understand the move though, one must consider how the dollar, and thanks to the PBOC’s peg, the yuan, was impacting its global rivals. Mirroring the U.S. dollar’s appreciation versus the euro, yen, pound, and Canadian dollar, the yuan vaulted higher against those same counterparts, as evidenced below on the remarkably similar chart, also courtesy of Oanda.com (2nd chart).

Concerns over sustainable growth in China have been simmering for some time in global markets. With the move this week, the PBOC hopes to slow or reverse that decline. The PBOC is charged primarily with maintaining the growth of the Chinese economy. This move, they likely believe, is the best way to ensure growth.

It is not difficult to understand why the Chinese felt pressure. The Eurozone is the largest destination for Chinese exports, even ahead of the United States, according to China Daily. And Japan resides firmly in China’s top five export partners. Unfortunately for Chinese exporters, European and Japanese purchasing power has eroded nearly 19 percent in the past year alone.

Exports are a major driver of the Chinese economy and the yuan’s devaluation effectively makes Chinese exports two percent cheaper for those paying in Yuan. China has a relatively huge trade surplus, reflecting the fact that they export far more than they import, though this surplus has been declining for the past three months and is expected to continue. The Chinese anticipate this move will alleviate some of that pressure.

Who wins in this situation? Clearly the move is designed to support Chinese exporters — the obvious winners. The Chinese likely would not have executed the move without this belief. With the goal of stemming declining growth, the PBOC removed any doubt as to who would benefit. Overseas importers of Chinese goods also benefit with the aforementioned price decrease.

On the other side of the coin, however, exporters to China are the initial and obvious victims. Instantly, un-hedged liabilities to Chinese companies became two percent more expensive.

Exporters to Asia should also be concerned as copy-cat moves by other Asian central banks could be in the offing in an attempt to remain regionally competitive. Add regional rivals of China to the list of potential losers. Similarly, U.S. companies looking to repatriate their un-hedged earnings will feel an immediate, proportionate blow.

Global markets witnessed and will continue to experience more volatility and uncertainty. If the devaluation fails to boost the Chinese economy to the PBOC’s liking, additional devaluations could follow, further disrupting markets. In addition, market participants now will question if the Chinese authorities have admitted that the pace of decline in the Chinese economy is worse than previous considered.

In The Spotlight

Much of the problem, however, is beyond the government’s control. Touching on a familiar theme, global weakness and flagging growth in the developed world could very well serve to undermine any recovery in the Chinese export sector. If fewer customers come through the door, it won’t matter how cheap Chinese goods become.

In turn, President Obama will face a much tougher sell of the Trans-Pacific Partnership to a Congress and country already skeptical of what some see as a track record of unfair currency manipulations by Asian countries. China is not a party to the TPP, but the potential for similar moves elsewhere in Asia could inject a level of discomfort for those on the fence.

More devaluations also are likely to bolster the efforts of those pushing for inclusion of anti-manipulation language in any trade agreement. As a result, we can expect heightened rhetoric from Presidential candidates.

Surprising to many, however, a big potential loser of Chinese devaluation are the Chinese themselves.

Already existing in China is a cumbersome regime of capital controls and conversion limitations that affect locals and foreigners alike. Those restrictions might be enough to prevent the widespread adoption of the yuan in global trade. But now knowing that the figurative rug could be yanked out at any time by Chinese authorities further undermines Chinese credibility.

The PBOC has an expressed goal to achieve — in the eyes of the market — the status and credibility of a global reserve currency. It also hopes to receive the related benefits.

One can argue that central banks tend to manipulate their currencies. But the world’s leading central banks do not overtly manipulate currencies in manners similar to the Chinese recent actions recently. The Chinese move on this scale is virtually unprecedented.

Share

Peter Clifford
About The Author Peter Clifford
Peter Clifford is the Co-Founder of TRSRY, LLC., an early stage financial technology company specializing in foreign currency hedging and payment services for corporations.




Talkback (1)

  • Guest (Robert Heilman)

    Permalink

    Another important beneficiary of the devalued yuan is the Chinese worker. Over the last decade substantial wage increases for factory workers gradually eroded the Chinese cost advantage in world markets. As exports ebbed, employment has fallen off. Always attentive to broad dissatisfaction in the country, the government sees the devaluation as a move to again increase exports. Yes, the Chinese exporters are winners. But gains also flow to the factory workers who see increased employment opportunity.

Leave your comments

0

Quick Search

Stock Watch

1 DOW 20,932.66
-48.67 (-0.23%)    
2 NASDAQ 6,049.82
+0.88 (0.01%)    
3 S&P 2,385.08
-3.69 (-0.15%)    

FREE Impact Analysis

Get an inside perspective and stay on top of the most important issues in today's Global Economic Arena. Subscribe to The Manzella Report's FREE Impact Analysis Newsletter today!