Yuan and Done

It’s not often that policy makers have a chance to achieve two goals at once, but that’s precisely what the Chinese government has done.

While American politicians make it sound like a fresh revelation every time they accuse the Chinese of manipulating their currency, the fact that the Chinese government controls the value of its currency hasn’t been a secret for years. The People’s Bank of China (PBOC) has used all of the policy tools at its disposal to keep the Chinese yuan, or renminbi as it is otherwise known, trading in a tight band around the U.S. dollar. The whole idea, and what sticks in the craw of American politicians, is to keep Chinese exports cheap vis-à-vis the dollar so that they’re more competitive in the global market.

That plan has worked out pretty well for the Chinese for years now, with cheap Chinese exports creating an era of virtually unprecedented prosperity for the country. That strategy has resulted in such prosperity that the government did an about-face a few years back to try to reorient their entire economic engine. Rather than relying on foreign buyers of Chinese goods, the government wants to create their own domestic markets.

That transition hasn’t exactly gone to plan. After years of relying on cheap exports and huge investments in infrastructure such as railroads, water projects and apartment high-rises to drive blistering growth, the Chinese economy has hit a rough patch. While gross domestic product is still at least officially growing at an annualized rate of 7%, the real estate and construction industries are struggling. The Chinese stock market has also been plunging while consumer spending is still anemic, further pressuring the economy.

Rather ironically, China has chosen to combat its sagging economy by doing what others have been pressuring it to do for years now – let its currency slide. The strong dollar has been a contributing factor to China’s woes, driving the currency artificially higher and making Chinese products more expensive on global markets. So on Tuesday, the PBOC performed what it called a one-time currency depreciation, allowing the yuan to drop by about 2% relative to the dollar. That was the biggest one-day drop for the yuan since 1994 and now the yuan is off by more than 4% so far this week as the PBOC has been allowing a wider trading range.

While this is still currency manipulation in the strictest sense, it’s a shrewd move by the Chinese.

For one thing, the devaluation is essentially a gift to Chinese exporters. The move will make everything from iPhones to clothing cheaper for American and European consumers. While that is a step back from the government’s domestication plan, as far as the government is concerned it will be worth it to get the economy humming again.

As I wrote about in my early July article China Adds Economic Firepower, China is eager to see its currency added to the Special Drawing Rights (SDR) basket of currencies maintained by the International Monetary Fund. That would essentially elevate the yuan to a global reserve currency, a status coveted by the PBOC. One of the major factors standing in the way of that is the government’s tight control of its value.

So by devaluing and allowing the yuan to float in a wider band relative to other global currencies, not only does it give its exporters a boost, it increases the odds of the yuan eventually being added to the SDR basket. Talk about killing two birds with one stone.