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China slowdown forces devaluation – what impact?

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What was the main reason behind China’s devaluation? One thought is that the 8% decline in exports from China in July may have spooked the Chinese government. Another thought is that China’s currency, pegged to the US dollar, and as the US dollar continues to strengthen, it makes Chinese exports less competitive. Whatever the reasons the devaluation has sent signals that China’s economy is not performing as expected and that government officials do not believe that 7% growth rate is accurate.

The share market mess has also added to the belief that the demand for everything will decrease because of China’s slowdown.

As far as wool imports are concerned, China continues to increase its imports of greasy wool from Australia. In the last season it imported 13.5% more wool in 2014/15 season than in the 2013/14 season.

Whatever the reason to devalue the decision of the People’s Bank of China (PBOC) to devalue the yuan by 1.9% will have global ramifications, in the short, medium and long-ish term.

So what are the implications of China’s intervention beyond its borders? For starters, because the yuan heavily influences regional exchange rates, China’s devaluations have hurt other Asian currencies as well. The Indian rupee, Indonesian rupiah, and Thai baht fell 2.7 percent, 2.6 percent, and 1.4 percent, respectively, against the dollar over the past week. For big trading partners, the devaluations will make Chinese imports cheaper, creating a risk of imported deflation, including in the U.S. And although that deflation risk could conceivably affect the timing of the Federal Reserve’s interest rate hike, Credit Suisse believes the central bank wants to get on with it badly enough to pull the trigger in September.

Falling prices are a touchier subject for Europe, where the economic recovery is still nascent and fears of sustained deflation prompted the European Central Bank to introduce a bond-buying program earlier this year. If a believable specter of deflation reappears, the central bank would almost certainly extend its commitment to quantitative easing, while economies outside the Eurozone, such as Sweden, would also likely opt for easy policy. The ECB might even add to its stimulus, depending how much further the yuan weakens. At a time when the Federal Reserve and Bank of England are ready to tighten, relatively loose policy would make European stocks attractive.

Immediately it will increase the competitiveness of China’s exports at a time when the country’s economy is growing at its slowest rate for six years – and when many economists fear that the slowdown will become much more painful and acute.

And for all the spur to growth it may give, the devaluation will reawaken concerns that Beijing is still a million miles from having re-engineered the Chinese economy to deliver more balanced growth based on stronger domestic consumer demand.

The weakening of the currency will also put the US Fed on the spot. One senior US bank official has already stated that due to the situation in China the increase in the interest rate in the US will be less likely.

A BBC commentator elegantly stated ‘in effect China is exporting deflation to the US – and so some will argue that the Fed should find an elegant way to back away from its recent signalling that September will see the first rise in interest rates since the Crash of 2008. Or to put it another way, in terms of US manufacturers and exporters, Beijing has done the monetary tightening that arguably the US economy needs.’

As for the medium term ramifications, China will yet again spark concern in Congress that it engages in unfair trade competition.

Doubtless presidential candidates, especially on the Republican side, will complain more about China’s attempt to rebuild export market share than fret about the implications of its seemingly unstoppable slowdown.

In the longer term it is unclear whether the devaluation will set back China’s ambitions for the yuan (also known as the RMB) to become a reserve currency, as per the IMF’s definition.

IMF economists and central bankers who adjudicate reserve currency status take into account whether a central bank forces devaluations or revaluations in a way that distorts the operation of a free market.

The PBOC is saying that in weakening the yuan overnight it is also moving to a more market-determined exchange rate.

And that may be so, in the sense that in recent weeks all the market pressure on the yuan has been downward – because of the unfortunate fact that the flaws in China’s economy have become more and more conspicuous.

The Editor

 

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