China devalues yuan a second time

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Kiwi under pressure after second yuan devaluation

China's second currency devaluation in two days has rattled markets across the region and put pressure on the New Zealand dollar.

The People's Bank of China devalued the currency for a second day in a row.   Photo: AFP

Radio NZ,

13 August, 2015

The People's Bank of China yesterday devalued the currency against the US dollar by 1.6 percent on after cutting its value by 1.9 percent the day before.

The yuan fell another 1 percent yesterday, marking the biggest two-day lowering of its rate against the dollar in more than two decades.

The New Zealand dollar touched six-year lows, dropping nearly half a cent against its American counterpart to US64.7 cents at one stage yesterday before rebounding. At 5.30am today it was trading at US66.25 cents.

Foreign exchange adviser Derek Rankin told Morning Report the foreign exchange market had been volatile, with minute-by-minute changes, but the New Zealand dollar was expected to continue to fall overall.

"The danger is that other currencies are going to be affected by this as well, and that's why they call it currency wars, because everyone's trying to have a weak currency to try and help their exporters.

"And, of course, not every one can have a weak currency," he said.

China's central bank has revised the way it calculates its guidance rate to better reflect market forces. The new rate is meant to boost exports and help boost China's flagging economy, and further devaluations are considered likely.

Analysts say the devaluation is bad news for New Zealand exporters, particularly for commodities like dairy products which are priced in US dollars and are now more expensive to Chinese consumer.

The move sent fresh shockwaves through Asian stock markets, which fell more than 1 percent.

Concerns about China's stalling growth have also been compounded by fresh data on industrial production, retail sales and fixed-asset investment, all of which came in below market expectations.

Figures released at the weekend showed Chinese exports fell more than 8 percent in July, adding to concerns the world's second largest economy is heading for a slowdown.

Rate more market-based

Yesterday, China's central bank fixed the "official midpoint" for the yuan down 1.6 percent to 6.3306 against the dollar. The midpoint is a guiding rate, from which trade can rise or fall 2 percent during the day.

Until Tuesday, that rate had been determined solely by the People's Bank of China (PBOC) itself.

But the rate will now be based on overnight global market developments and how the currency finished the previous trading day.

The devaluation could mean Chinese exporters, in particular textile and car companies, may become more competitive, as Chinese consumer goods will be cheaper for foreign retailers. But exporters to China are likely will find it harder to sell their goods.

China's currency devaluation could spark 'tidal wave of deflation'

The Guardian,

12 August, 2015

“Make no mistake, this is the start of something big, something ugly.” City economist Albert Edwards rarely minces his words, but his reaction to China’s devaluation, which sent shockwaves through global markets, underlined how powerfully Beijing’s move may be felt thousands of miles way.

Edwards, of the bank Société Générale, argues that as well as creating a challenge for China’s Asian rivals, by making its exports more competitive, a cheaper yuan will send “a tidal wave of deflation” breaking over the world economy.

Central banks in the US and the UK have primed investors for interest rate rises, with the Bank of England Mark Carney pointing to the turn of the year for a move, and Janet Yellen, at the Federal Reserve, signalling that a tightening could start as soon as September.

Edwards argues that instead of pushing up rates, central banks in the west should be preparing themselves to ward off a deflationary slump.

In the period running up to the financial crisis of 2008, which became known as the “Great Moderation”, inflation in the west was kept under control by the influx of cheap commodities and consumer goods from China and other low-wage economies.

Economies including the UK and the US were able to expand more rapidly than they otherwise might have done, without generating a surge in inflation.

But today, with inflation already close to zero – indeed at zero in the UK – China’s decision to devalue could bring a fresh wave of price weakness to the west.

Cheap goods are great news when economic demand is relatively strong; but economists fret about falling prices because entrenched deflation can prompt businesses and consumers to postpone spending – hoping prices have farther to fall – and blunt policymakers’ standard tool of interest rate cuts.

Erik Britton, of City consultancy Fathom, said: “We’re all going to feel it: we’ll feel it through commodities; we’ll feel it through manufactured goods exports, not just from China but from everywhere that has to compete with it; and we’ll feel it through wages.”

At the very least, analysts believe China’s move could persuade monetary policymakers to stay their hand. “If there’s deflation in the system, is the Fed going to be tightening? The answer is, no,” said Simon Derrick, of BNY Mellon.

Britton believes Carney’s strong hints that a rate rise is on the way could also prove premature. “In the UK, you’re not going to see tightening any time soon.”

Where economic demand is already fragile – in the eurozone, for example – the effects of deflation are likely to be felt more strongly.

Fathom believes China could be willing to let the yuan depreciate by as much as 25% over the next five years – “stone by stone, step by step” – in an attempt to restore the export-led growth that was such a winning formula in the decade running up to the global financial crisis.

How much more Beijing is willing to go is likely to depend partly on its motivations. There are at least three theories.

The first, and most benign, is that the People’s Bank of China is keen to show the yuan is a truly free-floating currency, in order to win inclusion in the basket used by the International Monetary Fund to determine the value of member-countries’ Special Drawing Rights – in effect the IMF’s internal currency.

A decision about composition of the SDR is expected in September next year. Putting the IMF’s imprimatur on the yuan in this way could start to open the way for its use as a global reserve currency, and this latest move could be seen as a way of winning the approval of the Washington-based lender.

But a jarring move could infuriate the Americans, who have the whip-hand at the IMF, so if this is the primary motivation, it might suggest Beijing will proceed with caution.

Second, and slightly less reassuring, is the idea that China is trying to buy itself a bit of insurance against a coming Fed rate rise.

Pegging the Chinese currency against the dollar has become increasingly costly, with the dollar up as much as 21% against other global currencies since spring of last year, and although China’s foreign exchange reserves remain vast, the central bank has been forced to dip into them to support the currency.

Simon Evenett, a trade expert at the University of St Gallen in Switzerland, believes China is trying to protect itself against the period of financial instability that can follow monetary tightening, by pre-emptively weakening the link between the yuan and the greenback.

“Plenty of studies have shown that rising interest rates in Washington have precipitated crises in emerging markets, whose knock-on effects can’t be reliably predicted. Preservation of options may provide the best account for Tuesday’s steps by the People’s Bank of China,” said Evenett.

But third, and perhaps most alarming, is the argument that China has resorted to devaluing its currency in a desperate attempt to stabilise economic growth, as other levers have failed.

Chinese policymakers have been engaged in a gargantuan effort to switch their export-dependent economy, reliant on volatile international demand, to another engine: consumer spending at home.

At the same time, they are battling to bring more competition and free market approaches to stodgy state industries; and to tackle the legacy of an unsustainable borrowing binge, including bubbles in the property and stock markets.

These would be a formidable set of challenges for any political leaders, and while the state of the Chinese economy is hard to assess, a number of warning signs have been flashing, including a share price plunge on a scale reminiscent of the US’s 1929 Wall Street crash and most recently, an 8.3% drop in exports in July.

Official figures show GDP growth in line with Beijing’s 7% target; but Fathom’s analysts, who study other measures, such as electricity usage and freight volumes, say it appears to be closer to 4%. Britton describes the depreciation as “China, doubling-down on its bet,” and warned: “If we are right about the hardness of the landing they’re facing, you ain’t seen nothing yet.”

Adam Posen, of the Peterson Institute of International Economics in Washington, says China’s motivation may only become clear over time, but markets will be asking themselves “is depreciation a side-effect of liberalisation or is liberalisation cover for devaluation?”

But whatever the reasons behind it, Beijing’s economic gear shift will have far-reaching effects. Not everyone is as apocalyptic as Edwards; but he believes the new wave of deflation emanating from China could “overwhelm already struggling corporate profitability and take us back into outright recession”.

“As investors realise yet another recession beckons, without any normalisation of either interest rates or fiscal imbalances in this cycle, expect a financial market rout every bit as large as 2008.”

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