• Making sense of China’s currency float

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    Ben D. Kritz

    Ben D. Kritz

    ON Tuesday, the People’s Bank of China (PBOC) sprung a surprise on the rest of the world by devaluing the yuan, allowing it to depreciate by nearly two percent, its biggest single-day change in almost 20 years.

    This naturally threw global financial markets into a bit of a tizzy; here in the Philippines, the peso reacted by shedding 23 centavos from its opening to close at a new five-year low of P45.93 to $1, with trading volume more than doubling from Monday to reach $1.1 billion. Tuesday’s close was the lowest level for the peso since late July 2010, when it bottomed out at P45.97 to $1.

    Under “ordinary” circumstances, the way in which the PBOC manages the value of the yuan is to set a daily reference rate against the US dollar, and then allow currency trading within a range of plus or minus 2 percent from that indicated rate. What the PBOC did on Tuesday was to, instead, set the reference rate at close to the market closing rate from the previous day, rather than resetting the rate to a more arbitrary target based on longer-term monetary policy strategy.

    Since 2005, when China more or less officially unpegged the yuan from the dollar, that strategy has been to allow the yuan to gradually rise over time as the Chinese economy expanded. The strategy is driven partly by economic logic, and partly by politics: one of the biggest criticisms of Chinese monetary policy by the western world is that China artificially depresses the value of its currency to prop up domestic industries. China’s government, of course, has always denied this, but it has to bend at least a little, because the criticism raises a few hurdles to the bigger goal of internationalizing the yuan.

    The recent deferral of a decision by the International Monetary Fund of whether to include the yuan in the currency basket that determines the value of the SDR (special drawing rights—the contrived currency unit used by the IMF, which at the moment has a value of about $0.72) may have encouraged the PBOC’s move on Tuesday, as well as the general cooling of the Chinese economy.

    According to the Chinese, Tuesday’s devaluation was simply a bit of housekeeping, a one-off reset of the yuan to closer to market rates to make subsequent setting of the daily reference rate a little more accurate. Based on the huge volume of commentary and analysis about the move, the rest of the world seems genuinely confused about what China may be up to; opinions seem to be fairly evenly divided between accepting the PBOC’s explanation, or taking the devaluation as a sign that the Chinese government is more worried about the economic slowdown than they’re letting on.

    The latter view gains a little bit of credence from the fact that August is the “ghost month,” when economic activity of all kinds tends to wane. Skepticism of China’s original explanation grew further when the devaluation happened again yesterday, shaving a further 1.62 percent off the yuan’s reference rate.

    The biggest benefit to China from the devaluation is to make its exports relatively cheaper; conversely, it presents problems for import-dependent businesses.

    For the rest of the world, the benefits are cheaper Chinese imports and lower commodity prices, but the length of time these advantages can actually be enjoyed is extremely short; in real terms, it may have lasted a couple hours on Tuesday afternoon, but was over by Wednesday morning. That is because other countries, particularly countries that rely on two-way trade with China (like the Philippines) have to allow their own currencies to depreciate in order to help their exports stay competitive with China’s, and to keep Chinese imports of Philippine goods from being priced out of that market. This raises fears of a currency war, in which everyone is “racing to the bottom” to try to maintain competitive equilibrium.

    If that happens, the Philippines could be in for a rough ride. A strong dollar and flagging domestic economic conditions are already putting negative pressure on the peso, and the yuan devaluation—particularly if it turns out to be the start of a more volatile downward trend rather than the “one-off” housekeeping the PBOC said it was—simply amplifies that.

    Further aggravating the problem is the very real possibility now, at least in the view of some analysts, that the US Federal Reserve may hold off a bit longer on its interest rate hike that was presumed to be in the pipeline for next month; monetary authorities and market watchers here have been counting on that to help ease the value of the dollar and slow or stop the peso’s slide, and without it, more aggressive action on the part of the BSP—which may or may not be a good idea in the long run—will be necessary to achieve the same result.

    ben.kritz@manilatimes.net.

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    4 Comments

    1. Boycott china made goods.What goes up must come down.Chinese were very arrogant and also their government. Now its their time to go down. Hope they land safely. Buti nga sa kanila.

    2. Justaskingseriously on

      It has been commonly believed for years now that the Chinese hold in their control the economic welfare of the United States of America, because the Chinese hold so much of America’s debts. I guess that means the Chinese have bought so much of the U.S. Treasury notes that the U.S. Treasury must pay in time with interest. Yahoo news yesterday described as barely a “shrug” the U.S. financial response when China unloaded billions of treasury notes. Then today the same Yahoo news took note of the acute lowering of the ratio between chinese job seekers and job offers. The worrisome meltdown of the chinese stock market made China apparently surrender (finally) to the market forces. Their refusal to let their currency “float” for several years now could no longer be maintained. I suppose, the chinese financial enigma inside a mystery is a riddle that is now unravelled. An economic unravelling can be seen as a microcosm of a person splurging beyond one’s means. Just think of all the chinese constructions of entire ghost cities. Think of all the island reclamations. August came and the ghost came too. They succumbed to the idea that “if you build, they will come.” Well, imagine the loads of money the nouveau riche plunked into those ghost cities to keep the money inside the country. The local currency has come to bite the local folks. Time to get real with the actual value of the local currency. The Chinese have only themselves to blame for their unsustainable manipulations. But I doubt that that would stop all manipulations.

    3. Amnata Pundit on

      There is already a currency war and its merely covered up with flimsy excuses wrapped in jargon to hide the ugly and scary truth: the world’s financial system is a grand ponzi scheme and its current slow motion collapse could end in a shooting war. China wants the names of everybody who sold a stock since the downslide started because it suspects that this is the result of an attack by American financial forces and they are investigating. They already suspended the operations of an American hedge fund whose name I forgot for the suspicion that its part of the assault on their stock market. The devaluation is an inevitable response to prevent the uncontrolled outflow of capital. The Vietnamese have also started to devalue as a result. I suspect the peso will continue its devaluation against the dollar just like all other currencies, so what will happen to the big companies who borrowed in dollars ignoring completely the lessons of 1983 and the 1997 Asian Crisis? Maybe the Central bank instead of wasting away its reserves by intervening directly in the exchange rate should form a subsidiary – never mind what its charter says as who obeys the rules nowadays anyway?- and use its dollar reserves to absorb these dollar loans and convert them to pesos, before the shit hits the fan. If the U.S. Fed can bail out Wall St., we can bail out our own too, right? Take note that something similar was done right after EDSA but the beneficiaries were limited to the businessmen who supported Cory. But will CB’s real masters who are fronted for by the IMF, World Bank and the BIS allow it? In case of a massive corporate debt default caused by a catastrophic fall of the peso the international loan sharks will gobble up all their assets for a song. Remember that all that money these sharks loaned out was just printed out of thin air. A category 8 storm is coming and nobody here is even talking of buying raincoats and umbrellas.