China's Currency: Yuan Blood, You Got It

It's animal - living in a human zoo
Animal - the s--t that they toss at you

I am convinced that AC/DC was singing about the political economy of exchange rates in the abovementioned song. If you ask me, the most important price in the world economy is none other than the USD/CNY exchange rate. Of course, this price is "heavily managed," a euphemism for the Chinese government having a heavy hand in its determination via measures including unprecedented levels of reserve accumulation--all $2 trillion and counting of it. Its determination has little to do with being either "free" or "market"-based.

China has long been on a collision course with the US over this trade practice, and the incoming Obama administration will likely take a less relaxed attitude to it. During the heyday of global economic imbalances not so long ago, protectionist forces in the US were balanced by the fake prosperity of cheap consumer credit care of surplus-running countries like China. Conversely, burgeoning exports meant the PRC could appease its critics by gradually appreciating. Those restraints have since bitten the dust as weakened American industries seek a big, bad scapegoat and the Chinese government tries to blunt the social consequences of a stalling export machine. At last, we may soon be witness to a long-awaited clash--not necessarily a bad thing, some say.

This topic is a favorite one among these parts, and I have been persuaded to post again on it by two recent finds. MarketWatch is out with an article suggesting that China is set to reverse course and gradually depreciate its currency after three years of steady nominal appreciation since abandoning a hard dollar peg. The article suggests that while depreciating the yuan won't do much to encourage spending in hard-hit deficit-running countries, it will send a signal that the Communist Party still cares about its people at a time when large-scale unrest caused by migrant laborers losing their jobs is a distinct possibility:

China's currency is expected to continue to weaken against the U.S. dollar in coming months, albeit at a moderate pace, as authorities weigh the political and economic benefits of a weaker currency in propping up the export-oriented economy.

Analysts say a measured decline in the yuan lasting about six months would not be out of tune with statements by senior Chinese economic leaders Wednesday calling for the yuan to remain "overall stable at a reasonable equilibrium level."

"They want to send a message that they could depreciate the currency a little bit," said Sebastien Barbe, senior economist for Asia, Calyon Credit Agricole, in Hong Kong. "They want to avoid a shock on expectations and igniting capital outflows."

References to the currency were issued Wednesday by China's top leadership at the conclusion of the three-day Central Economic Conference, a forum which usually sets the tone for economic policies in the coming year.

Analysts said currency stability was understood by the market to mean limited movement against the dollar and other leading currencies on a weekly basis. Bigger moves, they say, could spark an exodus of investment capital, copy-cat devaluation among regional neighbors, and protectionist sentiments with leading trading partners.

"From my point of view stability means no big fluctuations, it does not mean absolute stability of the currency versus the U.S. dollar," Barbe said, adding the yuan could fall up to 6% against the dollar over the coming half year...

Further weakness in the yuan would extend a trend change that began Dec. 1 when it fell by its daily limit 0.5% against the dollar, a move that analysts say signaled China no longer viewed a stronger currency as desirable.

Economists believe currency devaluation would do little to spur overseas demand for Chinese made goods. Still, a small-scale easing might have political benefits and help shore up company earnings which are being squeezed by a "growth shock" as China's export's growth decelerates.

"It an important political message to companies and migrant workers losing their jobs," said Dong Tao, chief economist Greater China for Credit Suisse in Hong Kong. "China's problem is not losing competitiveness but that demand disappeared." Tao added that he expected China to move into deflation for a brief period next year. Falling prices, he added, would further pressure corporate earnings and damp consumer spending at a time when the economy is already slowing, presenting a major challenge for policy makers.

Data released Wednesday showed China's exports declined 2.2% in November on year, the first such contraction in more than seven years, underscoring the severity of the global slowdown. The decline was the first on a monthly basis since February 2002.

I am very sceptical that gradual depreciation of the yuan will be enough to appease American and European exporters who've long sought action on China's currency policy. If they were unhappy with the rate of yuan appreciation before, there's little reason to believe that any sort of depreciation will cheer them up now. Add sour times and the dogs of trade war look set to be unleashed.

For those who are more circumspect about an impending trade war and less interested in finding out who's mightier in geopolitical terms, I also have something for you. The news that China's exports declined on a year-on-year basis has probably been heard by many. However, a recent Bloomberg article also had a noteworthy statement from a Chinese official:

The yuan’s biggest one-day decline in three years on Dec. 1. prompted speculation that China may allow its currency to depreciate, helping exporters by making their products cheaper in overseas markets. The yuan may weaken as much as 10 percent against the dollar, Morgan Stanley said last week.

Commerce Minister Chen Deming denied last week that China would rely on the currency to help exporters, saying that “the cause of the current problem with exports is shrinking demand, not problems with currencies.”

Those leery of trade conflicts should hope Comrade Chen and like-minded apparatchiks have more influence on China's internal politics than the export lobby. Certainly, WTO negotiations coming up short once again doesn't help matters. Otherwise, cue up the AC/DC: blood on the streets, blood on the rocks, blood in the gutter, every last drop...