Things aren’t looking particularly good for the Chinese economy. Nonetheless, the country’s economic leaders are assuring the international community that the government will not engage in any further currency devaluation. Anxiety over Beijing perpetuating a so-called “Currency War” against its international counterparts has not effectively been quelled yet.
What Exactly is the Currency War?
Simply put, a currency war is a “race to the bottom.” Each country tries to devalue its respective national currency in an attempt to be more competitive on the global markets. Although this sounds counterintuitive, the intention is to boost exports by making them cheaper for people in overseas markets to buy.
China has been front and center in this race to devalue. Repeatedly, the People’s Republic has ensured that a cheap yuan keeps its export numbers incredibly high. This has been an essential ingredient in the country’s strategy over the last quarter-century of large-scale production—hence the ubiquitous “Made in China” labels. In fact, the Chinese government still maintains a separate exchange rate for its offshore and onshore transactions.
These measures have, however, drawn criticisms of currency manipulation from China’s international counterparts. No doubt, devaluing the yuan has been among China’s primary tools for dominating global trade (in addition to its enormous manufacturing capacity).
At the gathering of G20 leaders in China last weekend, avoiding all manner of currency war was one of the prime topics of discussion. (This is the first time that China has ever hosted one of these meetings between political leaders and central bank governors from the major economies around the world.
U.S. Treasury Secretary Jack Lew expressed concern that the People’s Bank of China was still engaging in unpredictable currency devaluations. To this, Chinese Premier Li Keqiang and PBOC Governor Zhou Xiaochuan both responded by saying that no such actions would be taken. At the meeting representatives of the IMF suggested that, at any rate, such actions ought to be coordinated with proper forewarning and approval of other central banks and the international community. For instance, the PBOC could have chosen to spread out last fall’s 2% devaluation of the yuan across several weeks rather than in a single day, causing widespread panic around the markets.
Alas, the G20 meetings produced no tangible agreements, so the suggestion by the IMF is non-binding. No formal consultation process was outlined, either.
Naturally, state intervention in China pushed the yuan to its weakest against the dollar in over 5 years just two days after the meetings. The PBOC followed up this move by cutting its cash reserve ratio by 0.5%, further contributing to the drop.
Adding to the problem is the fact that the Chinese economy appears to be in for a rough adjustment. In addition to dramatically cutting its total steel and coal output over the next 5 years. (China’s surplus of steel alone is more than the annual production of Japan, Germany, and the U.S. combined. In a single month, China produces 80% of the steel that the entire EU—28 nations—produces all year.)
As a result, 5 million to 6 million state workers will be laid off over the next 2 to 3 years. This also entails shutting down “zombie” industrial firms that are bloated and unprofitable. Yet, because these zombies hold so much bad debt, it must be dealt with gradually or it could bring down the entire Chinese system. Clearly, a sluggish China won’t be the one to pull the global economy out of its current slump.
Moreover, rating service Moody’s is worried about that huge lump of debt China is holding. Moody’s may consider downgrading the government’s credit rating based on these findings.
Of course, China’s richest man isn’t sweating the abundance of signs about economic slowdown. If I were the richest person in a nation of nearly 1.5 billion people, I probably wouldn’t worry about much either.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.