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Financial planning tips

August 19, 2015

Dramatic drop in Chinese yuan

Just weeks after shutting down its stock market to halt a sudden drop in share prices, China appears to have engineered a devaluation of its currency.

Two weeks ago, I wrote about the end of the commodity super cycle triggered in part by an effort in China to transform its economy from one dependent on heavy industry, infrastructure development and exports to a more balanced model that emphasizes lighter industry, services and domestic consumer spending in an increasingly urbanized economy. The government’s long-term plan to develop a kind of state-sponsored capitalism has been a genuine game-changer for the global economy.

But this summer, two surprise moves by the Chinese government have prompted questions about its commitment to free and open markets. First came the decision to halt stock trading amidst a sharp downturn in valuations. The second followed last week – China’s yuan fell 3.9% against the U.S. dollar between Tuesday and Friday. It was the most dramatic drop in the Chinese currency (also referred to as the renminbi) since the 1990s.

To understand what’s going on, I spoke with Kip Beckman, principal economist, world outlook at The Conference Board of Canada on Monday.

“For years, they depended for growth on investment and exports,” said Beckman. “But they know that can’t last. There’s a lot of overcapacity. The difficulty they’re experiencing now is that growth is slipping below their 7% target. That’s why they’ve been doing things like cutting interest rates, lowering the reserve requirements for their banks and most recently the devaluation of the yuan.”

As the Chinese economy continues to develop, the country is losing its ability to disrupt export markets with inexpensive labour to countries like Bangladesh and Vietnam. As the middle class continues to grow in China, it is a challenge for policy makers to maintain economic growth and employment levels.

Beckman has harsh words for China’s move on the stock market.

“I think the government panicked,” he told me. “Things have stabilized now, but if you want to have an economy based on capitalist principals, you have to accept volatility in the stock market.”

Beckman sees the move on the yuan in similar terms. “Their goal is to have the yuan trade more on its own without government intervention,” he said. “But I think this recent move was an attempt to maybe try to help their exports. A competitor like Japan – their currency has been going down. Probably the Chinese government figures they’re losing market share. So in a sense there is a sort of currency war going around. The problem is that nobody wins because if all the currencies are depreciating, then nobody’s really winning.”

While the actions taken to stem stock market losses were pretty transparent, there is less agreement on what triggered the yuan’s devaluation. “[I]t is wrong to see this as a political move,” wrote Yves Tiberghien, co-director of UBC’s master of public policy and global affairs program and a senior fellow at the Asia-Pacific Foundation of Canada in The Globe and Mail on Saturday. Tiberghien contends that what we saw last week is part of the government’s efforts to allow the yuan to trade freely on open markets.

Time will tell. What’s clear is that this economic transition will require the very best of Chinese policy makers. It’s taken enormous creativity to get China’s economy this far. They’ll need even more.

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