Chinese Yuan devaluation

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If you have been reading the news about the Chinese Yuan devaluation in the last weeks, you will probably not have a clear idea of what is happening with the Yuan right now. I have read all sort of articles, from good ones (not many) to others that miss the point by a mile, because they don’t understand the way chinese economy works but need to write about it because it’s the story of the day. And others that do understand China but look at the trees instead of looking at the forest.

As I say, many of the good stories that I have read have a point: the CNY has devalued because China has changed the way it used to set the price of the RMB every day, giving a little more room to the market, as demanded by the IMF to grant the yuan the status of reserve currency, and to include it in special drawing right (SDR) basket. China wants this, at this moment, basically because of the prestige it gives (the only four currencies in the SDR basket are EUR, USD, GBY and JPY)

But what is really happening is what we already commented in December that would probably happen this year: the slow decoupling of the CNY from the USD. It’s very likely that the FED will increase rates in their September meeting. If the increase is too sharp or the wording is not very careful, it will cause a big appreciation of the USD against all other currencies, hurting Chinese exporters. What most American media forgets is that Europe is the main trading partner of China, not the US. So China is in effect giving a warning to the FED: if the USD appreciates too much because of US issues, China will not follow.

I am sure this warning is well understood, and that the FED will not rise rates by more than 0.25%, which is already discounted by the markets and should not affect the USD/EUR in a significant way. and in any case, they will use a very cautious wording to reassure everyone that their intention is not to indulge in a raising spree.

So, from my point of view, the depreciation of the RMB last week was a very good timed and very well planned move, a signal to both the IMF and, especially, the FED, which has 3 positive effects (for the Chinese):
(1) It is a way to make the IMF happy and increase the chances of the CNY to be included in the SDR, giving China a well needed marketing coup at this moment

(2) It’s a warning to the american FED: if you increase the rates too much and the USD appreciates, we will not follow. They will listen.

(3) It’s a way to help their exporters, that are struggling because of the transition from an investment led economy to a consumption led one

It has a negative effect: markets do not like it and fall, not in a good moment because Chinese markets were already falling (because a bubble is deflating). But Chinese government has coped with domestic markets panic before, as they did in 2006. And international markets… markets are stupid, short termism and herd effect are amplified, and next week they will have forgotten and focus on next week’s events, they have more important things to worry about.

How does all this affect us importers from China? It should help moderate the appreciation of the USD, which should not increase a lot or reach parity… yet.

 

Marc Torras

GISP

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