|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!) ?