China’s Currency Depreciation Is Not An Opening Salvo In A Currency War

RMB vs USD chart, 10 year time series

HAVING SIGNALED AS recently as late last month a widening of the yuan’s trading band, authorities have opted for a ‘one-off’ devaluation of the currency. The People’s Bank of China on Tuesday set its daily fix 1.9% lower than the previous day, its biggest daily shift since introducing the system, and taking the currency to a three-year low.

At the same time, the central bank said that future fixes would pay more heed to both the previous evening’s closing price and movements in the foreign-exchange markets. It will also seek to drive closer convergence between on- and offshore exchange rates.

This Bystander retains the view that these changes are primarily steps in the direction of eventual full convertibility of the yuan rather than a ‘currency-wars’-sparking devaluation to bolster exports and thus boost the slowing economy. Rebalancing the economy and securing IMF SDR status remain higher policy and propaganda priorities. Both require liberalised foreign-exchange markets.

As the chart above shows, the currency has been moving modestly lower against the dollar since the beginning of last year having seen a steady appreciation for the previous eight and a half years. However, as the chart also shows, the central bank has been holding a lid on that depreciation most recently, probably for fear of destabilising capital outflows.

In the short term, the central bank’s unexpected policy change will likely let the currency drift lower than it would otherwise have done. But the key point is that depreciation — and its reversal if and when it comes — will be driven more by market forces than administrative fiat.

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