The folks over at the People’s Bank of China (PBOC) sure know a thing or two about being aggressive, as they’ve dragged the value of their local currency down for three consecutive days. With that, market analysts can’t seem to stop buzzing about its implications on the global economy, the potential repercussions in the forex market, and whether or not it’s time to panic.
Wait a minute. The Chinese yuan isn’t really a major currency, right?
You got that right! The yuan isn’t usually an actively traded currency since its value is only allowed to float inside a fixed range in reference to a basket of currencies. The Chinese central bank sets the reference rate against the U.S. dollar every day and the yuan isn’t allowed to move by more than 1% from this level.
This week alone, they’ve set the reference rate 1.9% lower on Tuesday, pushed it even lower by 1.6% on Wednesday, and dragged it down by an additional 1.1% on Thursday. In their Tuesday announcement, the PBOC claimed that the yuan devaluation is just a one-time thing… before following it up with a couple more reference rate adjustments and a statement suggesting that further devaluation is possible. So much for credibility.
What in the forex world was that all about?!
Several economic experts say that the latest trade figures from China are to blame for the PBOC’s frantic action. The report indicated that Chinese exports plunged by 8.3% in July, its sharpest decline in four months, and that imports tumbled by 8.1% due to weak local demand. Shipments to the European Union fell by 12.3% while exports to Japan dropped by 13%. In addition, China recorded a 1.3% reduction in exports to the U.S. – its first decline in trade activity with its biggest market.
This probably set off a bunch of alarm bells in the PBOC, prompting central bank officials to come up with something to shore up trade activity. Bear in mind that China is the world’s second largest economy and is the top buyer of goods from several developed nations, so what happens in China doesn’t stay in China.
So why did they decide on yuan devaluation?
A depreciated local currency makes the country’s exports more affordable while letting imports become more expensive. Because of that, devaluation helps boost demand for the country’s products and puts upward pressure on domestic inflation, which is what almost every economy is hoping for these days. Talk about hitting two birds with one stone!
But, as ol’ Isaac Newton stated, for every action there is an equal and opposite reaction. In this case, what works out for China might have negative effects on other members of the global economy. Devaluation meant letting other foreign currencies rise in value against the yuan, consequently weighing on export activity and price levels in those nations. In effect, China dumped its problems on the rest of the world.
Yikes. Now what?
Well, it seems that market junkies are still trying to interpret these latest moves from the Chinese central bank, especially since the government has also been scrambling to stem the decline in their equity market not too long ago. Some say that Chinese authorities are starting to panic since they’re seeing bad omens in the country’s economic prospects.
This explains why comdolls and Asian currencies have sold off sharply after the PBOC’s devaluation announcements. If policymakers are THAT worried about exports, then demand for commodities and trade activity in the region must be in serious trouble.
But, as I mentioned earlier, China’s problems are everybody’s problems so the sooner the trade slump gets fixed, the better for everyone. For now, it’s too early to tell whether or not yuan devaluation will do the trick but it looks like commodity currencies are keeping their fingers crossed. Better keep close tabs on price levels and upcoming data from China to gauge if things are getting better or worse!