For about two decades China’s yuan was an anchor of stability for the global economy, helping it navigate Asian and global crises by holding steady even as other currencies slid. That era appears to be over.
The yuan fell for a third day as the central bank’s reference rate dropped 1.1 percent. It recorded its steepest fall in 21 years after the People’s Bank of China said Tuesday it will allow markets a greater role setting its value. Commodities from oil to industrial metals plunged and policy makers around the region weighed responses, with Vietnam widening the trading band for its currency on Wednesday.
An extended slide in the value of the yuan risks triggering a series of competitive devaluations and threatens a global deflation shock as prices of exports and commodities fall. Morgan Stanley said Wednesday that China’s export of deflationary pressures “is not a marginal event” given its $10 trillion economy and a deepening slump in producer prices.
“Until Tuesday the two biggest economies in the world -- the U.S. and China -- had shared the burden of stronger currencies,” said Stephen Jen, co-founder of London-based hedge fund SLJ Macro Partners LLP. “But we have likely seen China breaking off, leaving the U.S. as the sole economy bearing the burden.”
The currency realignment will lower profit margins and exports in the U.S., said Jen. It should also enable China and Asia to export some deflation to the rest of the world, he said.
The yuan’s depreciation will lead to a profit and export volume transfer from China’s trading partners into China, wrote Morgan Stanley analysts led by Head of Global FX Strategy Hans Redeker in London.
China’s economy needs a competitive devaluation against other Asian producers and that points to weak global growth, lower commodity prices and lower inflation worldwide, according to Bill Gross, a portfolio investor at Denver-based Janus Capital Group Inc.
In the short term, China’s currency move will amplify challenges to global growth and add volatility to markets that have lost some of their fundamental anchoring, wrote Bloomberg View columnist Mohamed El-Erian, former Co-Chief Investment Officer for Pacific Investment Management Co.
“The Chinese currency has been known for its predictability over the past two decades and now that has gone,” said Tao Dong, chief regional economist for Asia excluding Japan at Credit Suisse Group AG in Hong Kong. “China is the second largest economy, the biggest buyer of commodities and machineries, the anchor for Asian economies.”
Back in 2009, former PBOC deputy governor Zhu Min said plummeting exports had given China “good reason” to depreciate its currency during the global crisis and that it chose instead to keep the yuan stable. During the Asian Financial Crisis, then central bank Governor Dai Xianglong said despite increasing pressures from exporters, China was determined to maintain the value of its currency to provide a “much-needed anchor for the stability of Asia.”
“China had won international praise for keeping the yuan stable in the 1997 Asian Financial Crisis and 2008 global crisis,” said Chen Xingdong, chief China economist at BNP Paribas SA in Beijing. “But this time, China hasn’t received similar recognition from the IMF -- the incentive from the international side for China to keep a stable yuan exchange rate, therefore, is gone.”
Yuan depreciation will over time impact exporters to China, with South Korea, Japan and Malaysia among nations heavily exposed, said Callum Henderson, Singapore-based global head of foreign exchange research at Standard Chartered Plc. As for countries that import from China, “Japan and Korea will also import a disinflationary impact from this move, as will the euro area and U.S. to a lesser degree,” he said.
Bond markets underscore expectations for muted prices. Yields on two-year German government bonds fell to a two-year low Wednesday, touching minus 0.29 percent, the lowest since Bloomberg began collecting data in 1990.
The PBOC said Wednesday there’s no economic basis for the yuan to fall continuously and that it would strive to improve market-based settings and keep the exchange rate “basically stable.” It said major economic indicators had stabilized recently, providing a favorable macroeconomic environment for a stable currency.
The yuan devaluation also may be designed to bolster China’s case for gaining admission to the International Monetary Fund’s so-called Special Drawing Rights basket of currencies, which would bestow reserve currency status. While the IMF welcomed China’s move, it said there was no direct effect on its ongoing review of the SDR basket.
The yuan’s anchor role also may return given Chinese policy makers inclination toward stability, said Andrew Polk, Beijing based economist for the Conference Board.
“The PBOC still has plenty of tools to affect the exchange rate by intervening directly in the market,” Polk said. A lack of transparency about the central bank’s policy has increased volatility, he said.
Agent banks sold the dollar around the 6.43 level on behalf of the PBOC Wednesday, said one person familiar with the matter. The central bank didn’t reply to a fax seeking comment.
The devaluation followed an 8.3 percent fall in July’s exports and concerns over China’s declining competitiveness. The yuan had maintained its strength against the dollar even as the currencies of competing nations depreciated.
“No matter how reasonable it may be, this raises exchange-rate risk almost everywhere,” said Derek Scissors, a scholar at the American Enterprise Institute in Washington who focuses on Asia economic issues. “The magnitude is small, of course, but the impact is outsized because China had been such a strong source of currency stability.”