Why Did China Just Devalue the Yuan? How Trade Works with Free-Floating Currency
cassandracapital.net
cassandracapital.net
The interesting thing here is that the case is made that China can (and does) manipulate its currency and that devaluing one's currency is what has led to the shift of manufacturing jobs from the developed world to China (and other places) but it also notes that this suppression of currency value is becoming increasingly difficult.
Doesn't this support the argument that currency manipulation is ultimately time limited?
On a side note, I always like to point people to this [1] on the subject of free trade, specifically the conflation between free trade and free movement of capital.
If you’re interested in this topic I highly recommend “The Great Rebalancing” by Micheal Pettis. A really good book that looks at how currency manipulation and other factors have created imbalance in the global economy.
I’ve also written a book which touches on this - but focuses more on the massive sovereign debt burdens that have been created in large part though these trade imbalances - particularly in an aging world.
https://carnegieendowment.org/chinafinancialmarkets/
I have enjoyed his perspective for years.
Every country manipulate currency to some extent including USA. So why not revamp the system completely.
A country can have two of the following three w/r/t its currency (but not all three)
a fixed foreign exchange rate
free capital movement (absence of capital controls) # the USA likes this, or rather investors in the USA do
an independent monetary policy # most everyone wants this
China isn’t devaluing their currency, they are supporting it at its current level and artificially keeping it above 7.
When they stop supporting it, it decreases in value. Where would their currency go if they stopped propping it up?
https://www.npr.org/2019/08/05/748155575/chinas-currency-fal...
“China has long artificially propped up the value of its currency above the symbolic 7-to-1 threshold using a mixture of public and non-public methods, including ordering its massive state-run banks to buy up vast amounts of currency to strengthen the yuan, also known as the renminbi.
"The [Chinese] government has been, if anything, doing the opposite: protecting the renminbi from collapsing," says Jonas Short, head of China research at NSBO, an investment bank. "If you allow for the natural exchange rate for renminbi against the U.S. dollar, it should be about 7.2 to 7.3 per dollar."
>So for the last ten years, it has been closer to 6 RMB/usd than 7 RMB/usd. This couldn’t last, and the yuan’s natural market value was closer to 7
This was an artificial devaluing of their currency. It is called devaluing because it makes Yuan cheaper to buy (more exports from china) and USD harder to buy (less imports to china). From the title article: "China bids up the price of the dollar relative to the yuan by buying dollars with yuan, and then sits on these dollars".
>This couldn’t last, and the yuan’s natural market value was closer to 7, even above 7 and maybe even 8. If China does nothing, the RMB falls in value, not rises.
Historically, without interference, Yuan increases in value relative to the dollar (<7 RMB/usd). This makes Yuan harder to buy (Less exports from china) and USD cheaper to buy (More imports to china). This what the title article is discussing. Some believe that China has switched from devaluing to propping up the Yuan recentlyt
https://www.npr.org/2019/08/05/748155575/chinas-currency-fal...
>China's yuan plunged to below 7 per U.S. dollar on Monday morning
But that would be called a "rise" in the yuan. A "fall" in a currency always means the opposite, that the value of the currency has dropped. In the usage you're questioning, the yuan "fell" to 7+ to the dollar from its previously higher value of 6+. It's not a reduction in the number of yuan per dollar.
That's not what the article says, it only really addresses recent events. The main reason goods manufactured in China have historically been cheap is that Chinese labour and land is very inexpensive in absolute terms. They had huge amounts of land that was under-utilised and hundreds of millions of rural people with little or no economically valuable work to do, with very low standards of living. That's the basic source of China's manufacturing cost advantage.
It's also not true that China has consistently devalued their currency, they have frequently acted to prop up it's value especially since the financial crisis. Before 2007 the Yuan was much weaker, at over 8 to the dollar. The recent slide in the Yuan was a result of the latest tariffs. China didn't act to devalue it, they simply stopped acting to prop it up.
So overall yes, a relatively weak yuan has served China well, but much of that weakness is due to structural economic reasons. Labour and land was cheap due to low labour and land utilisation. Labour was also cheap due to very minimal standards of living. Manufacturing capacity was cheap due to enormous economies of scale. Those aren't a recipe leading to a naturally strong currency.
Capital controls and the peg are why real estate in China is a bubble. There's no other place for people to put their savings. Rich people who know better don't trust the CCP.
https://www.forbes.com/sites/andyjsemotiuk/2018/06/22/the-l-...
To make sure terms are correct, "Weak" currency means higher Yuan:USD conversion rate. Devaluing your currency makes exports more attractive to other countries and tends to create capital inflows (my 1 USD can buy a lot more Yuans, meaning cheaper to buy buildings/business!).
"Strong" currency means lower Yuan:USD conversion. Flip above.
Looking at the past, there's an odd floor that happens originally at 8.5 in the late 90s and 2000s. Many argued this was intentionally weak to help grow their export economy.
Then the rate rose to 6.83 in the late 00s and 2010s. Some argued this was intentionally strong to prevent capital outflows. Since then the rate has been in the 6s and seems to float more naturally until the recent dive into the >7s, indicating a weakening of the Yuan. People always saw 7:1 Yuan:USD as the weakest point China was willing to let their currency fall.
So, in the recent past, they're accused of artificially keeping the Yuan strong (esp in the global financial crisis) but now it seems like they're allowing it to devalue naturally.
EDIT: for details/grammer
Really, this is kind of what happened to every other east Asian economy the past 60 years. They grow at a rapid pace for about two decades, then hit a ceiling as their low currency value becomes a hindrance rather than a benefit.
Like the author explains, this is the Japanese model. And every country who has copied it as done so less effectively than the Japanese.
First Japan, then Korea, then Taiwan, now China.
For me, the fundamental advantage in this trade war with the US is that the Chinese are replaceable for the American economy. Sure, there will be some pains as companies move their factories from China to Vietnam (or wherever), but ultimately, there are other places in the world with cheap labor.
There is no other America in the world. China's number one customer is America and China doesn't seem to realize this. If you don't keep your relationship good with your number one customer, then you will lose them eventually.
And that's what's happening.
The Chinese have to get better at international relations or they will be more isolated as time goes on.
No one wants to deal with a partner who bullies them around. Especially when there are better deals on the table.
Before the trade war, which US goods had tariffs in China and how high were they?
The Chinese, by being labeled a "developing country" in the WTO agreement are allowed to have unequal tariffs on imported goods.
Really, it's not one thing with China, it's a list of problems:
1) Artificially controlled (and low) currency, making Chinese goods cheaper than American goods.
2) Specific tariffs on American goods (cars)
3) Industrial espionage of technology (Huawei)
4) Trademark theft (Apple and other luxury brands have literally fake stores all over China)
5) Intellectual property theft (DVD's, movies, ect..)
6) Geopolitical rivals. They often refuse to cooperate with US led efforts around the world.
7) Domestic Chinese political oppression. China is a police state and getting worse.
I think Americans are finally done with it. Why should we put up with all this? For cheaper cell phones?
What we can get from China, we can get from other countries without all the bullshit.
There are countless examples of industrial espionage as well as trademark theft. The Chinese refuse to do anything about it.
Americans finally wised up to this and the Chinese are now scrambling to find a solution, but the CCP has painted themselves into a corner.
Any concession to the US will be seen as an ultimate slap in the face to Chinese pride. The CCP has propped up it's legitimacy by blaming all their problems on "foreign influence". The US and the Japanese being the main two antagonists.
Well, if you tell your people that the US is fucking you, then you give in to them, then that makes you look weak and ineffective.
And it will hurt the CCP's political situation very badly.
But, it is clearly true that China's current position is not unlike that of Japan in the 90's, or South Korea not long after.
I think China's advantage is that they are big enough to create a large consumer market themselves. The U.S. was once in this position, as was the U.K. before them, and they both managed to make the transition from selling to other, richer markets to selling to themselves.
The big problem is, that both the U.K. and the U.S. had periods of internal stress during that transition, and because they were democracies they could blow off steam with electoral "revolts" instead of the literal kind of revolt. Perhaps China has the internal stability to be able to avoid this problem, but perhaps not.
Furthermore, the consumer market data includes food, which by a large extent has to remain a domestic product. If we assume that food is 11% of the market (based on "$1.46 trillion worth of food in 2014." in the US [1]), then:
US domestic market (without food): $13.32T ($11.85T)
EU domestic market (without food): $9.61T ($8.55T)
China domestic market (without food): $4.7T ($4.18T)
Japan domestic market (without food): $2.76T ($2.46T)
As you can see, China is not big enough, by a large margin.
[0]: https://en.wikipedia.org/wiki/List_of_largest_consumer_marke...
[1]: https://www.ers.usda.gov/topics/food-markets-prices/food-ser...
You could well bring up that 30 years ago China is about as wealthy as Africa, and that it is a total non-factor in the world economy.
The bottomline is this, China had 1.4 billion people, they will consume, even if they consume 1/4th as much individually, the market will be the same size as of the US. It probably already happened, just that services in China is much cheaper. Out of the 13T consumption that is the US market, how much of it is in the form of goods? You'll probably get the same level of service in China for 1/4 the price. The growth of consumption in China has been consistently greater than the growth of the economy as a whole for the past 10 years, and it'll likely happen in the foreseeable future as China's export shrink and infrastructure spending halts.
In addition, there is a lot of Chinese money that is going abroad, to buy real estate in Vancouver and etc. If this were all brought home as domestic demand, they would have an even larger market to sell into domestically.
But, this requires: 1) that it be spread out a little more evenly, and/or... 2) that the people with the money trust their future in China enough to bring it all home
Neither of which is easy. On the other hand, neither is impossible, so it could happen.
Is Trump & Brexit the "steam" in this analogy? Just asking.
The EU is a larger economy than the US, or at least has the same size.
The US might be the largest export market for China, but they only account for 20% for Chinese total exports.
China knows that while the US do not seem to always realise that China is their largest customer in a number of industries (ask soybean farmers or chipmakers).
As for the currency, well if you work in Forex you know that the yuan is actually over-valued (not under-valued!) so China does not have to devalue, they just need to do what the US ask them to i.e. let the market decide (that's what they've just done to send a message to the US).
> No one wants to deal with a partner who bullies them around.
Isn't that exactly what China should be thinking right now?
This is not as one-sided as you suggest.
A good recent piece on this by Paul Krugman in the NYT: https://www.nytimes.com/2019/08/08/opinion/trump-china-trade...
Why do you believe the Forex industry agrees the yuan is over-valued?
It is mainly a supply chain nexus.
That's also something America might need to hear in relation to other partners...
Using tariffs to constrain the actions of foreign central banks is really quite interesting. While China has succeeded in offsetting tariffs with inflation for now, they are paying for it by giving up policy flexibility, whereas the US can effectively control the price of the yuan with tariffs.
In a related issue, there's a theory making its circles in both right and left camps that if inflation is sub-par for a while, say below 2%, then printing more money won't cause problems.
Why inflation is lower than expected is an economic puzzle. But printing money to avoid paying debt may create new economic puzzles. If they try it, try it gradually please.
(The ideal annual inflation rate tends to be around 2.0% to 2.3%, based on historical record. This is in aggregate. Highs or lows tend to affect different people differently.)
$3T of dollar reserves would like to have a word with you.
b) China has used a lot of reserves propping up offshore RMB.
c) It's a lot more complicated than that.
d) 1.2 trillion in dollar debt has to be rolled over just this year
https://www.bloomberg.com/opinion/articles/2019-01-06/china-...
China's advantage is no longer cheap labor TBH...It hasn't been cheap for a long time now.
America is unique and important...But so is China.
Look what happened to Google. Google made all these concessions to the CCP and still got fucked.
China can't dangle the carrot of the Chinese market if they don't let American (or Japanese or European) companies have decent access to them.
China teases access, then pushes out the company after they steal their technology and intellectual property.
The world is finally wising up to this scam.
If you are old enough you will remember when Japan were the evil one in the 80's.
Or we can go to the history books and see how all those tactics is what the USA used against Britain.
I suppose we remember differently. An example: in 1991 George Friedman (the respected analyst, who, by the way, is predicting now the collapse of China) published "The coming war with Japan". Obviously the title is just "click-bait" but I think reflects what was in the zeitgeist then.
>>"China has always had a much more complicated relationship with the USA [..]"
Absolutely agree with that. After all, the constitution of Japan was basically redacted by the USA and militarily depends on the USA.
China is going to be a different matter and, that, I think, it's the real reason because China is considered even more "evil" than Japan, because subdue it it's going to be very difficult (if possible).
Pacifism a actually popular sentiment in japan; right wingers in the USA wish japan would drift away from that.
I don’t disagree, but it’s ironic that this was also the sentiment in the 40’s, and then Japan literally invaded (Alaska, after the surprise attack on Hawaii).
There has just to be a gung ho kind of movie for China, as far as I can tell. Likewise, Japan continued to be a top strategic ally of the USA in the 80s, it was never seen as a strategic competitor like China is today.
And comparing the USA and Britain is insane. It's like comparing brothers to complete strangers.
But Google's case is a different one. They soured their relationship with China by themselves. I don't see how it is beneficial to be openly rebellious to local government in the market you wish to operates.
Google made far too many concessions in my opinion and still got fucked.
Noteworthy to look at the top countries by trade surplus, where Germany represents the 900-pound gorilla:
Germany: +€111.9B
Ireland: +€33.9B
Netherlands: +€32.9B
Italy: +€22.1B
Czechia: +€10.8B
Everybody else is either close to zero, or negative. Here's the worst ones:
France: -€33.6B
Spain: -€15.8B
Greece: -€11.0B
Portugal: -€10.3B
[0]: https://trade.ec.europa.eu/doclib/docs/2013/december/tradoc_...
PS, @joshuafkon, you have an unnecessary apostrophe in the "it's" in the last sentence!
Say I’m a Chinese manufacturer of plates. I have an American customer buying 6m yuan worth every year. Previously that cost them $1m USD. Now it only costs them $857k. In both cases I’m getting 6m yuan, so I’m happy. Or, do I increase the price to 7m yuan because I know that’s what the customer Usually pays, now I’m VERY happy?
Does this achieve the goal of growth (6m to 7m yuan) or does it not count because the volume stayed the same?
Unless the "somewhere else" uses the yuan, currency devaluation doesn't work that way. Even if the exchange rate is tied to the dollar by fiat, devaluing it does so against all other currencies, because nobody is going to accept less yuan for their euros than they could get by exchanging euros for dollars and then dollars for yuan.
But that still doesn't mean they can raise prices, because the whole point of the currency devaluation is to make them more competitive. Raising prices does the opposite. And you can't claim the whole thing as margin if that would have caused you to lose the contract to begin with, which was the original reason for the currency devaluation. You may also have to compete with other local suppliers who are operating under the same nominal reduction in local costs.
Depends on the fees at each hop. A small fee could eat up the whole arbitration opportunity for our hypothetical EU or US buyer.
Absent the tariffs it would depend on the specific supply and demand for the good. I suspect both the manufacturer and the customer would split the value in some way.
Interestingly, the growth to the economy arises through how the devaluation impacts the savings and consumption rate for the countries in question. Weakening the yuan depresses Chinese household consumption and subsidies foreign household consumption. It is this change in national savings and consumption that drives the trade balance.
Earlier need to pay less but need to pay more due to devaluation. So it reduces profits and there by investments and capital expenditure.
That's the reason trade war is reverberated across globe especially in raw material and component countries like Australia, Germany, France, Japan and Korea.
This will bring down a global slow down not specific to China and USA. Since Global trade is always multi-lateral and impact can't be gauged completely.
Moreover investments are driven by perception and this lower profits and growth outlook will dampen the overall sentiments.
That depends on how you write your contract.
FOB or CIF? CFR perhaps. And what plates? Trade finance? Company finance? LOC? Volume of plates, consistency, mass, packing material, details on delivery?
Trade shipping contracts do go into 50 pages for a reason.
Since I can build a network online, since I can investigate laws online, even of other countries, since I can book and prepay for different steps to take in migration I have a much easier time than ever before to simply go somewhere else.
At the same time the psychological bonding between people and nations is lower than ever since the creation of nation states. If someone tells you they live at 20% the value they would want to live, just because they want to support their country, you would laugh about them.
And last but not least, more and more succeeding in the competition of production talent and creativity is more important than anything else. E.g. a soldier with low IQ and lots of muscles might have been great 500 years ago. But nowadays he simply gets shredded by a drone that was constructed by a nerd with technical talents and zero muscles.
Altogether it doesn't seem very logical to me that such a move can really improve China's situation, if it makes them lose talent quicker.
Till then everyday China need 504 million US$ to buy 8,400,000 bbl/day OPEC Oil to drive its economy; https://en.m.wikipedia.org/wiki/List_of_countries_by_oil_imp... and https://en.m.wikipedia.org/wiki/Petrocurrency#Currencies_use...
Hence China is selling/exporting its products/services to USA to EARN that $504 million/day; https://twitter.com/spectatorindex/status/116150270980923801...
>> Yuan is not able to escape China, and therefore while other countries might see capital flee the country long before the point China has reached. China has been able to prevent a collapse of its currency.
Why would Yuan escape China and why is it a bad thing for its currency?
If people believe that China is going to substantially devalue their currency, the will try to pull money out of the country and invest it elsewhere.
The risk is that the currency would then devalue more than China wants - to the point that they have very high inflation
https://chinaeconomicreview.com/for-china-the-risk-of-a-seco...
Wouldn't a weakened Yuan make them want to move the wealth back, to capitalize on the new arbitrage?
The full quote is:
>> China has been able to maintain its system thus far, and may be able to maintain it longer than many expect, because unlike every other major economy, China has strict capital controls. Yuan is not able to escape China, and therefore while other countries might see capital flee the country long before the point China has reached. China has been able to prevent a collapse of its currency.
I think what it's talking about is people (both domestic and foreign) deciding it's a bad currency to be invested in, and trading it for better currencies. The currency is being held so out-of-whack from where market forces would naturally keep it, that if people were allowed to do that, the PRC's economy could experience significant negative effects.
I don't think they're saying the currency itself would escape, just the value it represents.
If yuan could leave China, people could buy 7.2 of them for a dollar, then turn around and sell only six of them to the Chinese gov't and get their dollar back.
As you can see, this creates an unsustainable situation. Thus, the Chinese gov't must prevent capital flight if they want to prop up their currency value. Otherwise, arbitrage will eventually bankrupt them.
These countries need to realize that being in debt to a foreign currency is never worth it. The short-term booming economy because of a market flooded with dollars doesn't ever outweigh long-term costs.
See: Argentina, Brazil
It seems to me that if a country imports more than it exports, it is getting a good deal. It exports stuff and gets more stuff in return.
Let's say the US were to export more stuff to China. Now American companies have more money to buy assets. If they use this money to buy assets in the US it would just cause inflation. The land prices go up, but the total amount of land owned stays the same. If they use the money to buy land in China, I am not sure that it would have much impact on the US economy.
I keep seeing claims that China is devaluing without numbers or context.
Here's a 10-year chart of the USD/CNY exchange rate:
https://www.xe.com/currencycharts/?from=USD&to=CNY&view=10Y
At the start of the current administration (Jan 2017), the rate stood at about 6.96. Today it stands at 7.04.
In the two years after the 2016 election (April 2018), the yuan had strengthened to 6.28.
According to this timeline, the first round of US tariffs hit on April 7, 2017.
https://www.reuters.com/article/us-usa-trade-china-timeline/...
From the announcement of the first round of tariffs, the yuan actually strengthened. It has only "weakened" in the last year, and then only back to a level that slightly exceeds that of Jan 2016.
Yet to hear the president and others tell it, China is on a currency devaluation bender the likes of which the world has never seen. Well, I'm not seeing it at least.
It seems that the 7.0 level was broadly seen as a line in the sand. But like all psychological levels, they rarely mean anything in the long term.
The trend is clearly for more yuan weakness based on the chart alone. Perhaps we'll even see even massive devaluation.
But so far that's just speculation. The chart tells a story of a massive bowl formation (strongest yuan point in Jan 2014) hinting at severe weakness ahead, but we're nowhere close to that at the moment.
Is China printing yuan to buy dollars? I thought the USD was accumulated from payments (in dollars) from exports to the USA.
Like most business, the rules of engagement are flexible dependent on those involved and their willingness to assume risk to gain a nominal advantage. Also like most businesses, the net outcome of increasing risk is not always in favor of the party taking the risk, however the net outcome is almost always in [someone's] favor. Thus, you can simplify the outcome of any risk into two categories: Internal Advantage & External Advantage.
-- Note: I don't use the term "disadvantage" as I prefer to force myself to think of things from a advantage/standing perspective. Any loss on a countries' part is a direct result of another country gaining some relative advantage. "What is the inherent risk with Action [X], and who gains from it?"
Now regarding the issue at hand, the recent moves between China & the United States:
China is responding to the United States assuming a greater degree of risk, and corresponding reward, through recent tariff changes.
They appear to be trying to mitigate the advantage the United States gained by their actions, and thus are responding as any rational party in this situation would by attempting to regain their original advantage. The value of the currencies is, while non-trivial from a macro-perspective, a non-issue compared to re-establishing a status quo of commerce volume and relative economic position.
The question that remains now is whether the net advantages of either nation shifts as a result of this recent exchange.
And of course, this also acts as a subsidy to consumption for other countries whose currencies can now purchase additional imports.»
The first paragraph is written by Michael Petteis. The second paragraph by the blog's author. That second paragraph is completely wrong. As Michael explains, an undervalued currency raises the cost of imports. Therefore it doesn't help "purchase additional imports".
For other countries, it subsidizes imports from the country with the undervalued currency.
He's not claiming that an undervalued currency helps that country purchase additional imports.
china's interest rate is still higher than than the us feds.
https://www.cnn.com/2019/08/19/investing/china-interest-rate...
So, is this one way to summarize it: The lowlier a country's populace is on the world stage, the better the balance of trade, and the more the country's elites benefit? Of course, this isn't true 100% across the board. Make a country's economy backwards enough, and its businesses will lose the ability to compete in high margin value add goods.
To look at whether or not the yuan is being devalued stop looking at it vs just the dollar but against all other currencies. The trade war is pushing up the dollar significantly.
Today's value vs Aug 19th 2018.
Yuan vs Euro 0.13 vs 0.13
Yuan vs Pound sterling 0.11 vs 0.12
Yuan vs Yen 15.11 vs 16.06
Yuan vs Indian Rupee 10.15 vs 10.14
TLDR: Yuan is basically the same, rather it's the dollar that's gaining.
The correct method is a trade-weighted basket of currencies. So if you trade 90% with India and 10% with Japan, you weight the moves accordingly.
By this method, the renmimbi has devalued. Just not by as much as it appears by just watching the dollar.
More critically, the Chinese government fixes the renmimbi-dollar trading range. This gives this pair (among others) special status over others.
Trump knows that China is in a weaker position than the US. However, all this gamesmanship (and gameswomanship) risks crashing both economies (and the world economy). Trump is willing to play chicken as long as the US has the edge. But chicken is still a risky game. An interesting economic experiment is underway. Unfortunately, we are the lab rats.