Every day the Chinese government sets a mid-point for trading of its currency prior to opening. The renminbi is then allowed to trade within a 2% band on either side of the setting. At this morning’s setting, Beijing put the mid-point 1.9% lower than it was yesterday. This is an unusually large amount and can be (is being) read as an effective devaluation of the currency.
What does this really mean?
In the late 1970s, when China made its turn away from Mao and toward western economics, it chose the tried-and-true road toward prosperity trod by every other successful post-WWII nation. It tied its currency to the dollar and offered access to cheap local labor in return for technology transfer.
Late in the last decade, the country ran out of cheap labor. So it was forced to begin to transform its economy from export-oriented, labor-intensive manufacturing to higher value-added more capital-intensive output and toward domestic rather than foreign demand. The orthodox, and almost always not so successful, method of kicking off this transition is to encourage a large appreciation of the currency. That causes low-end production to leave for cheaper labor countries like Vietnam or Afghanistan.
China, armed with a cadre of young, creative economists with PhDs from the best universities in the West, decided to do things slightly differently–to hold the currency relatively stable and to boost domestic wages by a lot to achieve the same end of making export-oriented manufacturing uneconomic. The idea is that this doesn’t bring the economy to screeching halt in the way currency appreciation does. So far this approach seems to be working–although the shift does involve slower growth and a lot of domestic disruption.
At the same time, forewarned by the immense damage done to Asian economies by speculative activity by the currency desks of the major international banks during the 1997-98 Asian economic crisis, China elected not to let its currency trade freely.
For some years, China has been upset about the fact that despite being the biggest global manufacturing power, and by Purchasing Power Parity measure the largest economy on earth, it has virtually no say in world financial or trade regulatory bodies. Those are dominated by the US and EU. The main reason for China’s limited influence is that its financial system isn’t open. (The other, of course, is that fearing China organizations like the new US-led Pacific trade alliance pointed excludes the Middle Kingdom.)
So China has been gradually lessening state control over the banks, the financial markets and the currency, in hopes of being admitted into the inner sanctums of bodies like the IMF.
In one sense, this is why China is becoming less rigid in its control of renminbi trading.
There’s no “good” time to let a currency float. China doesn’t want to cede control over currency movements at a time when the renminbi might appreciate a lot, since that would be a severe contractionary force. On the other hand, it doesn’t want the currency to fall through the floor either, since that would result in new export plants sprouting up all over the place.
China is growing more slowly than normal and is experiencing currency outflows as a result of that. Letting the currency slide a bit relieves some of the pressure–although it may simultaneously attract speculators to try to push the renminbi lower. So, yes, it is a sign of economic weakness. At the same time, the loosening comes shortly before the IMF will decide on admitting the renminbi as one of its reserve currencies. And it follows by a few months Beijing allowing banks to issue certificates of deposit at market rates, rather than at yields set by central planners. So it’s also a step toward a healthier, more economically advanced, future.
I think worries about the stability of the Chinese economy are overblown. I also think that traders are using the Beijing move as an excuse for selling that they’ve been wanting to do anyway. Beijing may have been the trigger for this, but it isn’t the cause.