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China’s Sly Devaluation

For the past few decades, China’s economic miracle has been a wonder of the world. We’ve seen double digit GDP growth (even accounting for exaggeration in the CCP’s official figures) and the rise of Beijing as a major player in global trade and military power. But after a whirlwind year that saw the value of Chinese stocks more than double, the market is taking some big hits, and the prospects for future growth are dimming.

As we’ve followed closely, President Xi Jinping seems to have been battening down the hatches, looking ahead to a period of major financial instability, pretty much since he took office. Now that the storm appears to have arrived, his government is taking radical steps to stop the damage. After the first few days of the collapse, for example, Beijing froze trading on the vast majority of listed companies; in effect, true to authoritarian nature, the Party simply ordered the market not to decline.

And then yesterday, Beijing devalued the renminbi by the largest amount since it switched to its current currency regime in 1994. Calling it a “convenient reform,” Bloomberg offers some solid analysis:

By allowing markets a bigger role in valuing the yuan exchange rate, the People’s Bank of China is ticking off a box in its campaign to internationalize its currency. Central to this plan is a bid to have the yuan accepted by the International Monetary Fund into its basket of reserve currencies, known as the Special Drawing Rights or SDR. That would place the yuan on par with the dollar, euro, yen and British pound, and boost China’s global stature.

China’s central bank has typically kept a tight rein on movements in its currency, setting a daily rate for the yuan and the dollar, sometimes in defiance of market forces.

Market-makers who submit prices for the PBOC’s reference rate will now have to consider the previous day’s closing rate, demand and supply, and changes in major currencies. Previous guidelines had no mention of these criteria.

[…]

The yuan’s real effective exchange rate — a measure that’s adjusted for inflation and trade with other nations — climbed 14 percent over the last four quarters and was the highest among 32 major currencies tracked by Bank for International Settlements indexes.

“The central bank would never admit they are weakening the currency to help exporters, but clearly they’re complaining about the real effective exchange rate’s strength,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB. “It is a way to kill two birds with one stone.”

China already wanted to devalue the renminbi, which its standing policy had more or less pegged to the dollar, in order to make its exports more desirable for Europe and the developing world: more favorable exchange rates with trading partners equals more exports, and like it or not, Beijing hasn’t been able to overcome the market forces keeping it from moving past the export-driven growth model. So by timing it to coincide with the market’s troubles, Beijing gets to save face. Savvy move.

But even if this sleight of hand works, that doesn’t solve the basic, structural problem underlying the Chinese market’s recent travails, and it raises questions about how Beijing will react when everybody is eventually forced to admit that most of its self-inflicted bubbles have popped. As Einstein is said to have remarked in a very different context “the great miracle of the universe is that there are no miracles.”

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