There were two stories for why China allowed the value of its currency to fall beginning on Tuesday, one of which makes the government look shortsighted and the other farsighted: It is looking to boost its export sector to combat a weakening economy or it is trying to liberalize its financial system as it ascends the global financial stage.
[Reposted from The New York Times | Neil Irwin | August 12, 2015]
After Wednesday’s events, the shortsighted, export-boost story is looking like the more powerful explanation of what China is up to.
The renminbi fell 1.6 percent against the dollar Wednesday after a 1.8 percent drop Tuesday. That amounts to an exceptionally steep two-day move in the exchange rate between the world’s largest economies.
There were signs the sell-off went beyond even what the Chinese officials themselves had hoped for. The People’s Bank of China issued a statement that “currently there is no basis for persistent depreciation” of the currency. Some traders report they see evidence the central bank is buying yuan to stem the declines.
The initial reaction out of the United States to the original liberalization of exchange rates Tuesday went in two directions. One was to shout “currency war,” arguing that China was engaging in a desperate measure to try to achieve some temporary economic gain at the expense of its rivals through currency devaluation. See, for example, the comments of Senator Chuck Schumer, a longtime critic of China’s currency practices.
In some of the halls of power in Washington, the reaction was more one of cautious optimism. The International Monetary Fund and United States Treasury adopted a wait-and-see view of the move. They have both been pushing China to liberalize its exchange rate policy so that it adapts more to market forces, and they were, it seemed, getting what they wanted.
(For a particularly sophisticated version of this argument, read this article by Nicholas Lardy, the China expert at the Peterson Institute for International Economics, who made arguments in line with the I.M.F. view; the Twitter feed of his boss, Adam Posen, is more skeptical.)
The fact that the sharp drop continued for a second day makes more plausible the idea that China is primarily motivated by a desire to advantage its exporters against competitors across Asia and beyond.
The more abrupt a move the government allows, the more the devaluation looks of a piece with China’s frantic efforts to prop up its stock market earlier this summer — a short-term, desperation solution to a pressing problem.
Contrast that with the moves the Federal Reserve, the Bank of Japan and the European Central Bank took at various points in the last few years to loosen monetary policy and spur higher domestic inflation and growth. They have been controversial, and no doubt resulted in devaluations of their respective currencies, but the actions were carefully telegraphed, thoughtfully explained and explicitly aimed at domestic conditions rather than manipulating exchange rates.
The Chinese central bank’s move, by contrast, came as a complete surprise. It was accompanied by only vague official communication and appears to be narrowly targeted at the exchange rate. And because the Chinese central bank is not independent from its government, it’s impossible to know whether politicians or technocrats are really pulling the strings on the policy.
The book is not written on China’s new currency policies; after all, they’re only two days old. But if the sell-off continues the way it did Wednesday, the blowback to China’s actions and talk of “currency wars” will only get louder, and the voices of praise for its move toward liberalization softer.
Taking place against a backdrop of sluggish global growth, a United States presidential campaign season that is getting underway and a Chinese economy that just might be in real trouble, that will make for an interesting autumn in international finance.
