PBOC's Move: Not a Currency War, But Not a Good Sign


The People’s Bank of China announced on Tuesday morning that it would initiate a “one-off depreciation” the renminbi by just under 2 percent. It justified the move by saying that this would ensure a more market-based rate for China’s currency—after weeks of bad economic news out of China, all signs have pointed toward a downward adjustment in the yuan. The move marks the biggest single-day move for the renminbi since 2005, when China let the renminbi float within a managed range, ending its days a fixed-rate currency pegged to the dollar. (A move that was, at the time, welcomed by the Bush administration.)

The reasons why the People’s Bank of China (PBOC), the country’s central bank, chose to devalue the renminbi at this time are more complex than they may appear on first glance. On first glance, it’s difficult to–and indeed unwise–to not read this move by the PBOC in light of the recent volatility in the Chinese stock market. The Shanghai Composite index saw its biggest drop since 2007 last month, casting doubt on the health of the Chinese economy overall. As China transitions from the investment-driven growth model that propelled it to the top of the global economic food chain to a demand-driven model, based on consumer spending, these sorts of growing pains were perhaps inevitable.

Thus, on first glance, it looks like the PBOC took this move on to marginally improve the standing of Chinese exporters on the global markets. The reasoning is as follows: China’s recent stock market volatility highlighted the poor fundamental of private Chinese companies, many of whom rely on exports to this day–according to the World Bank, exports continue to comprise around a third of Chinese GDP (though they fell precipitously in July). Given a new low for China’s expected growth rate this year, devaluing the currency is a quick and easy way to boost competitiveness, raising output, and, in theory, returns to shareholders. The cost, of course, would be the illusion that China was heading full-speed ahead toward a new economic paradigm based on market forces and consumer demand. Of course, as commentators elsewhere have noted, China’s reaction to stock market volatility should have put that reasoning to rest.

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The above explanation for the PBOC’s move, while appealing with its simple logic, is misleading and narrow in its focus on exporters. Consider that everything about China’s ongoing economic readjustment suggests that the leadership wants a strong yuan—particularly at a time when the country is looking to grow the size of its middle class and spur consumer spending, a strong currency is important to prevent capital from heading out of China. As Scott Cendrowski, writing for Fortune, noted after the PBOC’s move, “China’s domestic and international goals align with a stronger yuan.”

The key to understanding the PBOC’s move is recognizing that the renminbi, as it has existed since 2005, is a managed float currency. After de-pegging from the dollar in 2005, the PBOC continued to control the value of the currency by allowing it to float within a defined range of the dollar and a basket of other currencies—a range that has continued to gradually expand since 2005 and stands today at 2.0 percent. Thus, Tuesday’s move simply shows the PBOC acknowledging that the mid-point ought to be lower given the state of China’s economy. In a way, it’s a vindication of long-standing demands in the U.S. and elsewhere that China ought to let its currency move with its market. Of course, in the past we assumed that the direction could only have been upward given the trailblazing pace of Chinese growth. These days, things are looking down for China and so its currency is adjusting downward. Given signs on the horizon of an impending rise in rates by the U.S. Federal Reserve and the recent strengthening of the dollar against particularly the Euro and the Yen, the PBOC had to make a move.

It’s unclear how far-reaching and significant the effects of the PBOC’s move will be, but we didn’t just witness a declaration of a new currency war. If anything, the PBOC’s move shows that China’s economic managers, after taking a heavy-handed approach to keeping the country’s markets from entering free-fall, are taking a sober assessment of the country’s less-than-rosy situation.

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