Why the world's got all out of shape at China's "devaluation"..... if that's what this really is ? Oh, and a quick re-clarification of terms.

Thursday 13th August 2015

 

Why the world's got all out of shape at China's "devaluation"..... if that's what this really is ? Oh, and a quick re-clarification of terms.

Ref : "Yuan Drop Slows as PBOC Intervention Threat Ends Panic Selling", Bloomberg online

The story so far .... on Tuesday the Chinese central bank, the People's Bank of China (PBOC), signalled the end of its strategy of keeping the yuan pegged to the strong US$ by reducing the value of the currency by 1.9% at the daily fixing. It also implemented a new , more market-driven method of establishing the fixing rate by getting market makers to submit their suggested rate based on the previous day's close, foreign exchange supply and demand, and changes in other major FX rates. In doing so, it has passed some of the control of the fixing from the authorities to the market, though the yuan will still only be allowed to trade within a 2% range of that day's fix.

You'd have thought Armageddon had been announced, and at the time of writing the yuan has dropped about 3.3% of its value against the US$ in 2 and a bit days. Certainly, the move has big implications. To point out a few :

A desire for a more competitive currency reflects China's own concern at a slowing economy, and in particular at falling exports (down 8.3% y-on-y in July). Remember, some pundits are putting China's GDP growth at significantly lower levels than the official 7.0%

It sparks fears of currency wars as other exporting nations seek to maintain competitiveness by weakening their own currencies.

The reduced purchasing power of the yuan weighs heavily on commodity prices (think lower inflation) and already beleaguered commodity-producing nations that rely so much on China.

The move exports deflationary pressures and may influence the timing of upward rate moves, most importantly in the US where futures markets now put the probability of a hike in September at 40%  --  it was 55% on Monday.

 Perhaps predictably, US politicians have been queuing up to expound their conspiracy theories about China's intentions. But the US Treasury has cautiously welcomed the move, as have the IMF, of whom the US is the largest shareholder. We should also recognize that China's aspirations to see the yuan adopted as one of the IMF's reserve currencies will have played a big part in this. As the PBOC point out, China was widely praised (including by the IMF) for maintaining its US$ peg during the Asian crisis of the late nineties, and during the more recent global crisis, but has received none for doing so more recently. Rather, the IMF has been encouraging a move to a more open, freer market. One can hardly blame the Chinese if they oblige.

It has always been notoriously difficult to know what China's intentions are, hence the panic and hair-pulling across the markets. But the PBOC is at pains to point out that it retains the option of intervening in foreign exchange markets when limits are reached (as they already have, by all accounts) or when onshore and offshore yuan exchange rates differ too wildly (again, the PBOC stepped in heavily when the offshore rates reached 2.1% weaker....it's now 0.6%). Some are even suggesting that China's aims may already have been met. That's assuming a lot, but it is just possible that the markets may look back on this as something of a storm in a teacup. Many would disagree of course, but then that's what makes a market.

Is China's currency the yuan or the renminbi ?

In common usage, either one. In fact, the renminbi is the name of the currency, the yuan the unit of currency. Think of the UK, with its "sterling" currency, and "pound" unit. You wouldn't say "this costs 10 sterling  --  you'd say "this costs 10 pounds". Don't get hung up on it though ..... even the most august commentators and publications interchange yuan and renminbi quite freely.

Disinflation and Deflation

 These two terms are also frequently substituted for each other, erroneously as it happens because there is a difference though sometimes it seems pedantic to point it out. Disinflation is a slowing of an inflation rate (or upward price moves) say +1.0% to +0.5%. Deflation describes an actual fall in prices. An inflation rate of +0.5% moving to -0.5% would be a move into deflation.