August 26, 2015    3 minute read

China’s Currency Crisis

   August 26, 2015    3 minute read

China’s Currency Crisis

About eleven days ago, China’s central bank has devalued the Yuan to its lowest level against the US dollar in almost three years. This is the largest depreciation that China has witnessed over the past 20 years and the aftermath of such decision has frightened many investors across the world. But what are the main implications underpinning the Yuan’s devaluation? Why has this monetary change affected all the major stock market indexes worldwide?

First of all, China’s devaluation has been interpreted by many as a distress signal, meaning that the world’s second largest economy, accounting for 15.4% of global GDP, may be far weaker than presumed via official growth figures, indicating a 7% yearly growth. Over the past few years, China has been trying to change direction of the economy’s growth. Previously, strong export alone was the cause of Chinese growth engine, but now policymakers are focusing on consumer spending in order to keep the impressive growth sustainable, at least in the short run.

So, in such a delicate situation, the announcement of the Yuan’s devaluation comes as a signal that policymakers may be losing both patience and faith in this strategy and this monetary decision could be interpreted as an economic stimulus to foster growth.

Secondly, China has for long been known to produce cut-price consumer goods to be sold in virtually any country of the world. But as a consequence of high growth and gradual westernisation, China has faced an upward pressure on its cost structure: wages, price of raw materials and shipping costs have all risen over the past few years. As a consequence, China’s competitiveness has decreased up a point where other Asian players in consumer goods market, as Indonesia and South Korea, have recently gained larger market share. So, the yuan devaluation engineered by policymakers has sharpened China’s ability to compete in international markets, at least in the short run.

Even more importantly, the devaluation of the Yuan will have a strong impact on Central banks’ interest rates, that had been lowered to face depression caused by the credit crunch. US and UK policymakers have been warning of a possible rise of the interest rates, as the first timid signs of recovery started to emerge. Though, the strategic devaluation of the yuan will decrease Chinese goods’ prices, that will, in turn, create deflationary pressures on many countries importing goods from China. Consequently, if deflation would pose a real threat to growth, central bankers might consider a delay in deciding to rise the interest rate, which would create turbulence in international market.

Lastly, the effect of the Yuan devaluation is clear if we look at the international stock market, with both the S&P 500 and the Dow Jones indexes that have lost more than 5 percentage points in just 11 days after the announcement of the Yuan depreciation. Similar results come from Europe: the Eurostoxx 5o has lost 7 percentage points over the past 11 days and commodity markets have plummeted as well, as Chinese economy seems to cool off. In particular, oil price has suffered, with both the Brent and the WTI that are trading at their lowest level in almost 10 years.

So, to round off, it is evident that all this information conveyed by the depreciation of the Chinese national currency has induced many economists to revise downward the expectations for global growth in the years to come, as one of the biggest economy of the world is slowing down. Though, one last question is left to answer: who has ever thought that China could have sustained impressing growth rate constantly throughout time? Everyone knew that, sooner or later, even China would have started to settle on a long-term, sustainable growth path.

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