On the 10th of August 10 China dumbfounded global markets with its decision to devalue its currency, the yuan (also known as the renminbi), by nearly 2%. China is the world’s second largest economy and the currency is tightly controlled by setting a daily rate for the yuan versus the dollar.
The People’s Bank of China stated that the devaluation was a result of financial reform aimed at bringing the yuan ‘more in line with the market’. However, this action comes at a time of slowed economic growth in China and a weaker currency will reinvigorate Chinese exports enabling increased selling of goods abroad. Over the next three days after the announcement, the yuan lost approximately another 3% of its value against the dollar.
The plunge in the value of the yuan has been shaking world markets, and almost no major index is untouched by the ripple effect. Commodities took a substantial blow as China is one of the world’s largest consumers of varied raw materials, such as: iron ore, cotton and milk.
The devaluation and its consequences upon the US market in China could increase tensions between America and China ahead of the Chinese President’s meeting with President Barack Obama during his visit to the United States in September. China wishes to create greater acceptance abroad for the yuan through incorporation into a currency group tracked by the International Monetary Fund (IMF) may be severely hampered.
China’s devaluation may be seen as a distress signal from Beijing policymakers warning that the economy is far weaker than the 7% a year growth suggested by official figures. China has been attempting to engineer a shift from export based growth to an expansion based on consumer spending while simultaneously trying to deflate a property bubble. China may be losing patience with this strategy, and reaching for the familiar economic benefits of a cheap currency. Also, if the façade of Chinese economic strength is shattered, it will alarm companies hoping to export to China, such as Britain (China was the sixth-largest destination for British exports last year).
What does it all mean for Australia?
China’s influential economic and geo-political role in the Pacific-Oceania region means that offsets and regressions in China’s economy and currency will have widespread results upon countries in this region, most notably, Australia.
Australia has experienced an impressive economic boom in recent years on the back of selling natural resources, including coal and iron ore, to its Asian neighbours, and China accounts for more than 25% of its exports. Australian exports to China will become more expensive in the face of the yuan’s devaluation. This sector is the principal source of Australia’s gross domestic profit (GDP) and China’s reduced consumptions of Australian goods and resources as a result of this increased cost may hit the unprepared Australian economy hard.
Furthermore, Australians and other global citizens with business interest in China may also experience both positive and negatives as a result of the devaluation. A business that imports goods into China will suffer increased costs whereas businesses outside China which source goods in China will have decreased costs. Finally, businesses which sell a high proportion of goods in China may see a slip in demand because the Chinese have less purchasing power (especially problematic for a luxury goods business).
The global impact
Western observers and financial experts began to protest after the devaluation and subsequent fall in value of the yuan, accusing China of devaluing its currency deliberately in an attempt to make its exports cheaper and boost its flagging economy. Other financial analysts opposed this accusation by stating that this would be counterintuitive to China’s goal to register the yuan with the IMF. The whole truth is uncertain at this point in time but the global effects of devaluation can be assessed regardless of purported aims.
Some experts have stated that the Chinese devaluation does bring about a ‘tidal wave of deflation’ in the global economy and the most vulnerable countries will be those that are heavily indebted. While wages and profits fall in a deflationary period, the value of debts remains fixed, making them harder to pay interest on. Economies where consumer demand and confidence are already weak tend to bear an enhanced impacted as a result of the reduced spending that deflation can bring. Greece is already suffering deflation after repeated cuts in wages and benefits as the government tries to balance its, debt, revenues and loans. If deflation worsens in Greece it will only make its gargantuan debts (currently worth greater than 170% of the economy) more difficult to repay interest.
As the yuan devalues it appears cheaper from the perspective of American consumers. However, this is also true for Chinese consumers. The rising value of the dollar means it is getting more expensive for Chinese people to import American made goods. This is likely to lower US export rates to China possibly leading to marginally slower economic growth in the US. The same is true for other countries whose currencies are gaining value relative to the yuan’s devaluation. However, it’s important to remember that a cheaper yuan means Western consumers pay lower prices for Chinese goods. If the negative macroeconomic effects of China’s devaluation can be negated through free market measures and alternative growth it would ensue that devaluation has a positive benefit for countries like the US.
In countries like the US and Britain there are other possible boons to the Chinese devaluation:
– Lower Chinese economic growth could depress oil prices and thus lower costs for motorists.
– In coming months, weak Chinese demand in the natural resources sector could force down the cost of many commodities, from oil to iron ore (which will hit Australia especially hard).
– Other Chinese goods (T-shirts, toys, gadgets) may drop in price slightly.
The true fallout of Chinese devaluation remains to be seen yet it is imperative that consumers around the world continue normal consumption patterns as a reduced consumption and investment reaction could spell severe economic chaos worldwide.