Global currency and equity markets were roiled last week by the People’s Bank of China (PBOC)’s sudden devaluation of the renminbi on Tuesday.
In short, they moved to link the currency’s value closer to market forces.
The currency saw the biggest one-day drop since China ended its dual-currency system in 1994.
The media reaction has been borderline hysterical.
Just look at some of these headlines…
New York Times
Let me clear this up: China is NOT entering a currency war.
Rather, this is one of many bumps in the road that will occur as China continues opening up and integrating into global financial markets…
Now I can understand why the media rushed to the wrong conclusion. Weak China export data was released the previous week. And there is already an entrenched global currency devaluation narrative firmly in place… but still, just take a step back for a moment.
As we all know, one of the China’s key milestones for integration into global financial markets is the inclusion of the renminbi in the IMF’s Special Drawing Rights (SDR) currency basket.
IMF rules require a review of the SDR basket at least every five years. The next review was scheduled for later this year.
Now, earlier this month, the IMF staff report said that the decision on adding the renminbi to the SDR should be postponed until September 2016 (technically it could have been postponed until 2020).
Why? Because the IMF is clearly giving Beijing more time to satisfy its criteria of inclusion. And clearly, the way in which the currency is valued and traded in the market is one of those criteria.
The IMF has already described this latest currency policy move as a “welcome step as it should allow market forces to have a greater role in determining the exchange rate.”
So let me say again, this has nothing to do with “currency wars” or competitive devaluation!!!
In fact, I think the PBOC were taken back by the scale of reaction in both the media and in global markets.
On Thursday they called a press conference with top PBOC officials. This itself is astonishingly rare.
The Assistant Governor of the PBOC said:
“From the international and domestic economic and financial situation, we can see that there is no basis right now for continued depreciation of the renminbi exchange rate. The central bank has the power to maintain basic stability in the Rmb and ensure it remains at a reasonable and balanced level.”
The Deputy PBOC Governor also weighed in:
“When market fluctuations are too big, we can carry out effective management to provide the market with more confidence towards the exchange rate system and ensure greater stability in the market and the functioning of the economy.”
And what’s the key word repeated here?
Without getting too political, “stability” is the very bedrock of Chinese Communist Party legitimacy, both politically and economically.
In order to generate meaningful growth from competitive devaluation, we would need to see 20%+ depreciation of the currency.
Does that sound like stable policy? No.
So ignore the hysteria. China is a US$10 trillion economy going through the process of trying to integrate into the international monetary system. There will be more bumps like this.
The key is going to be our ability to differentiate real problems from technical ones like this.