Making Sense Of China’s Currency Devaluation

Earlier this week, two massive explosions rocked the Chinese port city of Tianjin. It’s said that the larger explosion was equivalent to over 20 tons of TNT being detonated. The blasts were so large that seismic activity was registered around 100 miles away.

The exact cause of the explosions is unknown, but other shocks emanating from China have clearer triggers.

On August 11, 2015, China devalued its currency, the renminbi (yuan), by 1.9%. It was the currency’s biggest one-day drop since 1994.

It didn’t stop there, either. At one point the following day, the yuan had cumulatively lost as much as 3.9% of its value against the dollar. Policymakers in China seem to be following through on their promise to allow the market to play a bigger role in determining the exchange rate.

“A fixed exchange rate looks stable, but it hides accumulated problems,” noted Yi Gang, Vice Governor of China’s central bank.

China doesn’t have a fixed peg, but it does heavily manage the yuan’s level relative to the U.S. dollar. The chart below helps us put the devaluation into perspective. The y-axis has been inverted so that a rising line shows yuan strength.

U.S. Dollar (USD)/Chinese Renminbi (CNY) Exchange Rate

As you can see, China allowed the yuan to significantly appreciate against the dollar from 2005 up until the credit crisis. The fixed peg was reinstituted from mid-2008 until mid-2010. Then, the yuan began a slower appreciation, which culminated in early 2014.

So, the yuan’s relatively small recent devaluation has only given back a small portion of its longer-term appreciation. That said, we shouldn’t downplay what’s happening right now.

The U.S. dollar bull market has really forced China’s hand. The dollar has been very strong over the past year against virtually all global currencies. Therefore, the yuan has been dragged higher. With a strong currency, China has lost some of its export competitiveness. China has also been burning through foreign exchange reserves to keep the yuan at a level above where it would naturally be.


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