In a surprising move, China has again this week moved to devalue its currency, the yuan. First acting on Tuesday in a nearly 2% devaluation, and again Wednesday with a devaluation of 1.6%, the government lowered the state enforced peg to the U.S. dollar. China has attempted to downplay fears associated with the move, despite broad opinion that the Chinese economy is at the start of a prolonged downward trend.
The sharp devaluations come after the Chinese government acted earlier this year to slow the huge drop in its stock market, restricting market activities such as short selling in addition to outright bans on the trading of some stocks. Because the yuan devaluation was preceded by these drastic interventions into the Chinese stock market, attempts to downplay the significance of the recent move will likely fall on deaf ears.
As the yuan drops in value, Chinese exports become more affordable in foreign markets, with foreign products then becoming more expensive in China. China has long suppressed the value of its currency in an effort to boost its exports to wealthier economies such as the U.S. and there are fears that the actions could lead to a currency war wherein competing economies will all devalue their currencies in an effort to gain a trade advantage.
Borrowers on mainland China will be upset with the news, as it will raise borrowing costs on the more than $960 billion owed to offshore banks. China’s devaluation will also threaten the possibility that its currency will be included this year in the IMF’s composite currency known as “Special Drawing Rights” (SDR). Until the recent move, the yuan had actually been gaining in value, rising 44% since 2007 against its trading partners.
With the U.S. economy still crawling out from the last recession, the move could prove to reverse that trend as U.S. markets are already responding negatively to the news. The dollar fell against the euro and the yen, as currency traders saw the recent devaluation by China as reason for the Fed to push back their interest rate hike.
As China continues to aspire to the status of a first-world economy, it seems that each passing week places them further from their goal. With a government that is willing to rewrite the rules of their stock market so drastically, little credence can be given to statements claiming the devaluations as a one-time event.