The increasing volatility seen in the Chinese yuan against the US dollar recently and fall to 18 month lows overnight has, irony of ironies, prompted the leaders of some of the G20 countries to point the finger at the PBOC and accuse them of a desperate attempt at currency manipulation to stave off the impending currency crunch. While for more than 20 years China has experienced epic growth rates, such growth cannot be perpetuated and thus the current deceleration does likely tempt the authorities to engage in competitive currency devaluations. However, the reality behind the current volatility may not actually be the result of intervention, but rather of a lack of it…
While I can certainly understand anyone complaining about currency devaluations, the truth is that people who live in glass houses should not throw stones, and many of those G20 countries houses are certainly encased in thin glass as some of them have pushed for extraordinary levels of quantitative easing, and which, in the end, has similar effects to a competitive devaluations.
Over the last few years, China has emerged as a world power, second only really to the US. In order to retain this hard won status the government has been investing hugely in infrastructure to continue to sustain economic growth and the PBOC has also pursued a policy of a strong yuan to contain inflation. Mixed with the hot money flows which have come about from the massive quantitative easing measures unfolded in the US, China has been a beneficiary of huge inflows of money and which have also contributed to a rising yuan.
During the last several years, it has seemed that the yuan has been a one-direction currency with steady and managed appreciations year on year. Banks have created a multitude of derivatives with this seeming single-direction in mind and in the process exposing corporate China to the risk of a yuan decline. With the weakness that we have seen this year of the CNY against most major currencies, many of these corporations are likely to be exposed should the yuan weaken much further, in particular if the rate declines below 6.20. Carry traders may have to look elsewhere for a new window of opportunity as this one may just be closing…
China has in fact been accumulating a great deal of dollar-denominated assets across the years with them, prior to the Fed riding to the rescue, being the biggest global buyer of US Treasury bonds. With the US government now at the end stage of the QE experiment and the dollar showing strength against selected currencies, this is beginning to concern some in China and the focus has shifted from the appreciation of the yuan to attempting to curb the current growth in foreign reserves. That means a likely departure from monetary intervention to a more flexible, market-driven approach of letting the yuan freely gyrate.
In mid-January, the PBOC began to set weaker fixings and then in mid-March, the central bank extended its policy by widening the daily trading band for the US dollar and the Chinese yuan, doubling it to +/- 2%. What is now happening is the exact opposite of what other G20 leaders are complaining about.
If the above is all true and the PBOC is indeed changing its attitude towards its currency, then I believe that the FED has not properly evaluated all the possible effects resulting from its quantitative easing program and dismissing the international consequences for the dollar. While in the short-term the weaker yuan may scare the carry traders away and pose some difficulties for Chinese companies, in the long-run it may help destroy the dollar hegemony in international trade. If we think about it, it just doesn’t make sense to have as an international means of payment, a currency from a highly indebted country (the U.S.) It will take time, but the dollar’s day of pre-eminence are drawing to a close.
Filipe R Costa