Sunday, August 23, 2015

Devaluation of the Chinese yen


                                                                               That is a lot. 

Devaluation of the Chinese yuan

Last week, over the course of a couple of days, China devalued its currency around 4 percent. This matters because currency devaluation can trigger a “race-to-the-bottom” effect – when a country weakens its currency, its prices are lowered, which increases its exports and market share because consumers want the cheaper products, which encourages other countries to do the same. 

There is much speculation over the cause of this rapid devaluation, which is the lowest the yuan has dropped in a 2-day period in a very long time. One thing most can agree on is that it reflects that China’s economy may not be as strong as the world thought it was and that its rapid yearly growth rate (the GDP used to increase by 7 percent every year) may be starting to falter. 

However, people think there is more to it than just an attempt to increase exports and boost the economy. I read lots of opinionated analysis on China’s reasons for devaluing. 

a) China has, in the past, been accused of initiating a “currency war,” which is another term for competitive devaluation. The United States has also, in the past, fallen victim to competitive devaluation, which causes loss of jobs and can force protectionist policies like the enactment of tariffs. Some news sources took the bad blood angle and “spun” the story to speculate that this may be the start of yet another currency war (http://www.cnbc.com/2015/08/21/currency-wars-whos-next-to-pull-the-trigger.html)

b) Others say no, starting a currency war won’t help China’s efforts to become an IMF reserve currency (http://www.wsj.com/articles/china-rallies-around-yuan-as-imf-mulls-reserve-currency-inclusion-1434366682), elevating it to the status of the likes of the dollar, the euro, the yen, and the pound sterling. Some articles I read (http://www.wsj.com/articles/china-moves-to-devalue-the-yuan-1439258401 and http://www.nytimes.com/2015/08/23/your-money/currency-devaluation-is-a-short-step-in-chinas-long-advance.html?_r=0) “spun” the story in a more forgiving way, defending China by saying it was only trying to loosen its grip on the yuan and try to determine it by market value, which is what the IMF wants – free-floating currency.

The difference between how the prices of currencies are determined: The U.S. dollar is “free-floating,” which means that its value is tied to the market. The Chinese yuan is not currently free-floating. The central bank, not the market, determines its value every day, but it can be assumed that the central bank takes the market into account. 

(Now, awkward transition as I try to connect this to what we’re learning in class right now. Sorry.) Both of these countries’ exchange rate regimes reflect, to an extent, the overall structure of how they run their governments. China exercises tight control, the United States lets the people decide what they want and hopes for the best. The advantage of free-floating currency is independence from other currencies and freedom from complicated intervention policies, the disadvantage of free-floating currency is volatility. The price of freedom is volatility. Is it worth it (in any case…feel free to talk about government or economics, but other examples are also welcome!) ? 

4 comments:

OdyssOrdain said...
This comment has been removed by the author.
Scott Chow said...

China's declining economy is occurring for a number of reasons, many of which are systematic and government perpetuated.

Take this article (http://www.nytimes.com/2015/08/30/business/international/zombie-factories-stalk-the-sputtering-chinese-economy.html) I found while doing the blog roll assignment. To summarize, it blames the declining economy on the production facilities of China out expanding the demand for the products. The Chinese government, with its powerful central government, keeps these dying businesses afloat by restructuring or renewing their loans. The Chinese government keeps these businesses alive because they fear the social unrest that might come from the widespread unemployment that would result from these businesses going under. These attempts to maintain the jobs of Chinese workers stems from the government's promise of "the iron rice bowl," which is their version of lifetime employment.

This decline of the Chinese yuan represents a series of complicated global economics that are putting the value of the yuan to the test. It is also, however, exposing the mismanagement of economic policies by the government. Aside from the iron-fist method of control, the Chinese is also making good use of political spin, such as with the buzz phrase "iron rice bowl." What that phrase fails to tell is the mixture of low pay and terrible working conditions that characterize the Chinese working environment. That being said, these conditions might be normal for the Chinese population, which would lessen the political spin on the phrase, but increase the overall spin done by the Chinese government on a whole.

This post might be subject to edits, which I will list below as they occur.

Scott Chow

Emily Shen said...

http://host.madison.com/hands-cartoon-farmer-works-hard-for-his-subsidy/image_f164009d-288e-5062-8249-10d915126246.html

Interesting point. The U.S. is guilty of this too. But the U.S. is actually good at it. We produce a TON of corn. Yet can you call our subsidies "successful" if there is so much stuff that we have to generate artificial demand? What does all that corn leave us with? HFCS, crappy beef, and maybe, in the long term, health problems for our nation?

Is it still ultimately better to let consumers decide what they want and let their desires control the market, even if we have to sacrifice Farmer Joe and Bessie the family cow in the process?

Janet Liu said...

That's a good question, Emily! From the point of view of sacrificing the farming culture, I can see how we might logically justify letting consumers dictate the market. Bringing it back to China though, and even a little deeper into American history, isn't it interesting that what the consumer wants isn't always good for their physical health either?

China's weak efforts to curb pollution synchronize with industrial America's own pollution problem, but China's federal government isn't about to whip up some version of the EPA, since (as Scott mentioned above) the survival of the free market (and JOBS) seems to be both the national government and the consumers' primary concern.

Who's left to champion the unpopular effort, and what exists to protect them? Sounds like we're going back to Federalist 10 again :)

Oh, and going back to question of currency, here's TIME magazine's take:

"Opening a controlled currency to the unpredictable pressures of supply and demand...takes steady nerves...There's a risk that volatility will create shock waves that a rigid political system can't absorb."

According to this perspective, Scott has a point about China's economy and currency taking hits from the cutthroat free market.

But the political system is what is to me the most interesting. Emily, it sounds like you have a point about volatility being a price of freedom; will China's government ultimately have to make some significant changes if they are to undertake the free market? What are the qualities of our government that have helped us to succeed where China hasn't?