Why a Drop in the Overvalued Yuan Won’t Start a Currency War
A week of mayhem in the financial markets, grandstanding lawmakers on Capitol Hill accusing China of “rigging the rules again”—all because the overvalued yuan depreciated toward a market rate in three dramatic trading sessions. Could we see some evidence of sobriety this week, please?
I’m not holding my breath. The reaction to the People’s Bank of China announcement last week that it was effectively devaluing the yuan by roughly 2 percent was a mix of misunderstanding and hypocrisy. The former does damage and the latter makes fools of people who should know better — in combination they’re just short of poisonous.
Ma Jun, chief economist at the PBoC issued a statement Sunday intended to steady the markets as they open Monday morning. First, he said China has “no need or intention to participate in a currency war.” I take this to be true, but with qualifications.
Then Ma warned investors to expect more “two-way volatility” in the yuan-dollar exchange rate. True without qualification, but you tell me how this assertion will go over.
Why did the markets react with so much volatility, and why was it unnecessary? The answer to the first has two parts.
One, the PBoC’s announcement was taken as a signal that China’s economy is slowing more dramatically than previous measures had indicated. The perception in the markets, The New York Times reported, was that China’s leaders are panicking.
You don’t have to look very hard to conclude that it was investors doing the panicking, not the technocrats in Beijing. That leads to the second point.
As a source in Asia put it in a note Sunday, “This has nothing to do with reality. Last May, the I.M.F. reported that the RMB [the renminbi, the yuan] was fairly valued. In the interval it has increased by about 5 percent on an REER basis.” REER, real effective exchange rate, uses a trade-weighted average to calculate currency values.
Another problem arises from ungrounded, not to say stupid expectations. Western advocates of market reforms in China were long ago lulled into a contradictory faith in the Communist Party’s ability to manage growth, currency rates, debt levels, and other macroeconomic factors. The unsayable truth, considered in this space years ago, is that American free-marketers doing business in China have been thoroughly invested in the Communist leadership’s command over the economy since Deng Xiaoping’s day.
Surprise! Beijing no longer has anything liked the control over the economy it did in the pre-Deng and Deng years. The yuan’s fall attests to this, indeed. And the change is by design, of course.
Surprise! China’s transition to a market-oriented model may not always work to the advantage of those who profess to love markets. Here a nasty question arises: Do free-market advocates favor reform in China when it’s good for their bottom lines but not when it isn’t? Hmmm.
As to why the severe market reaction was unnecessary, again, there are two parts to the answer.
One, last week’s depreciation didn’t tell anyone anything new about the slowdown in China. We already knew growth was decelerating. GDP is now ticking over at 7 percent per annum, and if this is grounds for panic, someone who panicked needs to explain.
Two, the currency move signaled that China was simply taking another step to mitigate the consequences of slower growth. Last time I looked, intervening to encourage growth—in this case by supporting export industries with a weaker currency—was a good thing, not an occasion for markets to gyrate and politicians to erupt in protest.
And so to the hypocrisy heaped atop the misunderstandings.
“For years China has rigged the rules and played games with its currency,” Chuck Schumer, the senior Democratic senator from New York, said last week. “Rather than changing their ways, the Chinese government seems to be doubling down.”
Jiminy Cricket. This guy is fighting the last war—and it has been over for years. Not to be rude, but Schumer and other longtime currency agitators on Capitol Hill have no clue what they’re talking about.
Every single industrialized nation without exception, and many in the developing world, has resorted to currency devaluation as a Band-Aid fix at one time or another. Holier-than-thou is a cardboard position at this point. Freshmen in economics won’t take it seriously.
China has gradually exposed the yuan to market pressures for a decade. What it did last week was adjust the median point that fixes a band within which the currency can trade against the dollar in its “managed floating exchange rate regime.” The yuan subsequently fell a further 1.4 percent—the market’s doing, not the PBoC’s, and evidence enough that the currency was overvalued.
Two points here. One, there’s no “doubling down” in this. In net terms the PBoC took a further step toward liberalization, given it will now refrain from intervening unless it judges market volatility too extreme. The International Monetary Fund, which told Beijing Friday it wants the yuan to float freely within three years, applauded the Chinese central bank on this basis.
Two, the PBoC’s move was craftily timed, for sure: It knew the market would do the rest of the work after its initial announcement. But then the central bank did intervene—this time to support the yuan against further depreciation.
“The PBoC has effectively defanged potential critics by offering just what has been asked of it—more currency flexibility,” said Eswar Prasad, a Cornell professor and formerly head of the International Monetary Fund’s China bureau.
I think we can forget about any currency war, Senator. Simply not at issue.
Schumer now opposes allowing the yuan into a basket of international reserve currencies “unless and until China stops artificially devaluing.” Wrong again. Requiring China to conform to global currency-management standards is exactly what we want to do now.
Letting the yuan drop to restore exporters’ competitiveness is hardly the answer to China’s economic challenges —numerous and fundamental as they are. It’s a grace note next to the truly big moves China has to make.
We should understand it as such, drop the sanctimony, and avoid more senseless panic this week.
Maybe we will. The note from my Asian source Sunday advises that the smart money is already piling into dim-sum bonds, yuan-denominated paper issued outside China. “So much for the fearful devaluation!” this source adds in mocking delight.