This week, China lowered its official target for the value of its currency relative to the U.S. dollar. Global news media promptly labeled this a “devaluation,” and the usual set of pundits and politicians denounced the move as “currency manipulation.”
But are these terms really accurate in this case? More broadly, what can a nation do to influence its currency’s exchange value and how does that affect its economy? And considering China’s size, how will this all influence the world economy?
China continues to grapple with a deteriorating economy. The latest indication of trouble was that exports in July dropped 8.3 percent from a year earlier. The government reacted by lowering its target value for the renminbi currency (also known as the yuan) in a series of steps beginning Tuesday. By the close of Chinese markets Thursday, the currency was worth over 3 percent less against the dollar than it had been at the start of the week.
Strictly speaking, this was not a “devaluation.” That term applies to a true fixed exchange rate regime, such as the Bretton Woods system that all the major noncommunist countries participated in for the first quarter-century after World War II. In such a system, rates are strictly fixed over long periods of time and are changed only when there is a “fundamental disequilibrium” that requires it. If a government then takes action to reduce the value of its currency relative to others, it is a “devaluation.” If it is increased, the term is “revaluation.”
The polar opposite is a pure floating rate system in which there is no official rate and the actual value of the currency rises and falls on a daily basis in response to supply and demand. The government, including the central bank, does not take any action to influence the exchange value of the currency. In normal times, the U.S. dollar has been in such a pure float since 1973. In such a system, the currency “appreciates” when its price goes up in terms of other currencies; it “depreciates” when that value falls for people or banks who exchange it for other currencies.
The renminbi falls somewhere in between. It is on a “crawling peg,” in which the People’s Bank of China, the nation’s central bank, specifies a target rate for the currency against the U.S. dollar or against the weighted average of a “basket” of several currencies. But this target rate is not rigid. The central bank may buy or sell renminbi to keep the actual rate at which commercial transactions are made near the target rate, but this market rate can fluctuate within a trading day and between days.
Fluctuate it does. Since 2007, on a monthly average basis, it has taken as few as 6.05 renminbi to buy a dollar or as many as 7.79. Over the past four years and on a daily basis, the range has been narrower, from 6.04 to 6.39. So the mid-6.3 range of this past week reflects a low value relative to the past few years, but a much higher value than long prevailed.
Given China’s higher inflation over the last several years, the effective exchange value of the renminbi is well above what it historically was when U.S. economists and politicians complained about the unfair advantage an artificially cheap currency gave China in terms of boosting its exports to our nation and raising the prices of imports from us, reducing the quantities of our products that the Chinese buy.
Since 1994, China obviously followed a general policy of keeping the exchange value of its money as low as possible to stimulate an export-based economy. That emulated the strategy set out for Japan by the post-war U.S. occupation government there, and those followed by every other Asian nation that has experienced rapid growth, including South Korea, Taiwan, Hong Kong and Singapore. Indeed, China has “manipulated” its currency, and I’ve written columns about this.
But, like “discrimination” in the civil rights debate, “manipulation” of exchange rates is very much in the eye of the beholder. Specifically, does lack of intent matter? The dramatic increase in the U.S. monetary base and resulting lowering of U.S. interest rates by the Federal Reserve, starting in 2008, certainly had the effect of making the U.S. dollar less valuable relative to other currencies, including China’s, than it would have been if the Fed had not engaged in successive waves of quantitative easing.
Did the Fed “intend” to manipulate the value of the dollar in a way that would boost U.S. exports and retard demand for imports? That certainly was not the primary objective of Fed policy, but it was an important and inevitable effect that every decision maker involved was fully aware of.
Ironically, the widespread condemnation of China’s actions this week by U.S. politicians ignores the fact that the Bank of China acted to avert an even larger fall. Market forces are driving the value of the renminbi down. China knows what happens to governments, such as myriad Latin American ones over the past century, that truculently try to maintain the value of a currency when market fundamentals demand it falls.
If the Chinese government simply stood back and let its currency float, its value would fall much faster and farther and the effects on U.S.-China trade balances would be far greater than what has happened. Then what would critics like Donald Trump and Democratic Sen. Charles Schumer think?
The effect of a less valuable renminbi, all other things being equal, will be to increase Chinese exports. This will at least partially recoup the disadvantage it experienced, relative to the euro and other non-dollar currencies, as the Chinese currency was dragged upward as a result of its close link to an appreciating dollar.
However, a cheap renminbi will be an enormous headache for any Chinese corporation or bank that borrowed abroad in dollars, euros, yen or any other foreign currency. Both the principal owed and payments due on those loans just got hiked. Moreover, as in 1997 in Korea and Hong Kong, the positions of sundry Chinese financial companies are highly opaque. Many must have high exposure to such foreign borrowing, but the true extent is unknown and, for now at least, unknowable. China’s new currency policy may be the least-bad option available to them, but it is a symptom of the extent of the fundamental disequilibriums within the Chinese economy that must eventually be resolved. We are far from the end of this tale.