Eight reasons why China’s currency crisis matters to us all.
After
China unexpectedly devalued its currency last Month, one City economist
shrugged despairingly and said: “It’s August.” While it’s meant to be a time
for heading for the beach or kicking back in the sunshine with the kids, August
has often witnessed the first cracks that presaged what later became profound
shifts in the tectonic plates of the global economy — from the Russian debt
default in 1998, to what Northern Rock boss Adam Applegarth called “the day the world changed,” when the first ripples of the credit
crunch were felt in 2007; to August 2011, when ratings agency Standard and
Poor’s sent shockwaves through financial markets by stripping America of its triple-AAA credit rating.
Taking the long
view, last week’s devaluation by China, which left the yuan about 3% weaker
against the dollar, was relatively modest — sterling had lost 16% of its value
in 1967 when Harold Wilson sought to reassure the British public about the
“pound in your pocket”.
But China’s decision
represented the largest yuan depreciation for 20 years; and the ripples may yet
be felt thousands of miles away. So what difference will it make to the rest of
the world?
1. It could be serious
China’s devaluation
may be best seen as a distress signal from Beijing policymakers – in which case
the world’s second-largest economy may be far weaker than the 7% a year growth that official figures suggests. China
has been trying to engineer a shift from export-led growth to an expansion
based on consumer spending – while simultaneously trying to deflate a property
bubble. Last week’s move, which loosened the yuan’s link to the value of the
dollar, suggested some policymakers may be losing patience with that strategy,
and reaching for the familiar prop of a cheap currency. Nobel prize-winning
economist Paul Krugman described the decision as “the first bite of the cherry,”suggesting
more could follow, and in a reference to Chinese president Xi Jinping, warned
that such a modest move gave the impression that, “when it comes to economic
policy Xi-who-must-be-obeyed has no idea what he’s doing”.
If its economy
really is much weaker than Beijing has let on, it would be alarming for any
company hoping to export to China — something firms in Britain have been
encouraged to do in recent years, to lessen reliance on the stodgy European
economies. China was the sixth-largest destination for British exports last
year.China will remain a vast market; but it may
not be quite such a one-way bet as some analysts have suggested. And when it
comes to the challenges facing Chinese policymakers, Russell Jones, of
consultancy Llewellyn Consulting says: “The potential for getting this wrong is
quite high.”
2. A less costly Christmas
China has been
trying to shift from being a vast factory producing cut-price consumer goods
for the rest of the world. Yet glance at the label on almost any T-shirt or toy
– let alone consumer gadget – and it’s still likely to read “Made in China”. A
country’s currency is not the only determinant of how much its goods will cost
when they reach the high street: Chinese wages have been rising, making its
products less competitive, and the price of raw materials and shipping is also
important. However, the devalued yuan will force China’s Asian rivals, such as
Indonesia and South Korea, to compete even harder in response; and the result
may be a few pence off the price of Chinese-made Christmas presents. Martin
Beck, of consultancy Oxford Economics,
says, “Almost 9% of the UK’s goods imports come from China, a share that has
doubled over the last decade.” So there will be a direct disinflationary effect
from cheaper imports.
3. Cheaper petrol at the pump
China’s apparently
insatiable demand for natural resources has been a key factors supporting the
price of oil in recent years. So fears that China’s economy is in trouble tend
to undermine oil prices – and that probably means cheaper petrol in Britain. Of
course, there are other factors, including strong oil production in the US; but
global oil prices resumed their decline last week following China’s move,
dipping back below $50 a barrel. In coming months, weak Chinese demand could
force down the cost of many commodities, from oil to iron ore.
4. Delayed rate rises
Central bankers in
the US and the UK have been issuing warnings for months that, with growth
strengthening, they are preparing to start pushing up interest rates –
reversing the emergency cuts made in the global credit crunch. Mark Carney, the
Bank of England governor, has suggested “the turn of the year” might be the moment to consider
tightening monetary policy (ie raising rates); Janet Yellen at the US Federal Reserve has signalled that
an increase could come as early as September. However, if the
cheaper yuan cuts the price of imports, this will undermine inflation, which is
already at zero in the UK; and could delay a rate rise. A renewed bout of
market turbulence as global investors assess the implications of China’s
decision could have the same effect.
5. Deflation, deflation, deflation
In the short term,
lower-than-expected borrowing costs will benefit indebted consumers in the west
– including Britain’s mortgage-holders. But some analysts believe China’s
decision is the latest evidence of a deep-seated lack of demand in the global
economy, which will unleash deflation. Brief periods of falling prices –
particularly if concentrated among one or two commodities – can be good news;
but economists fret about periods of persistently falling prices, which can
undermine spending and investment and feed through to wages, as consumers and
businesses delay spending, expecting goods to be even cheaper in future. And if
a fresh downturn does come, central bankers have little ammunition left to
tackle it, since interest rates in the US, the UK and Europe are already on the
floor. Economist Ann Pettifor, of thinktank
Prime, who foreshadowed the credit crunch in her 2006 book, The Coming First World Debt Crisis, believes the
developed economies face some of the challenges felt by Japan during its “lost
decade”, when it suffered both deflation and weak demand – but unlike Japan,
many developed economies, not least the UK, would enter any new crisis under a
heavy burden of borrowing. “It’s the pressure of debt on consumers, corporates,
municipalities,” Pettifor says, raising the spectre of the kind of debt trap
identified by the US economist Irving Fisher in the wake of the Great
Depression. Not everyone is so pessimistic, and Carney has shrugged off the
idea that deflation is a threat in the UK; but as Neil Mellor, of BNY Mellon,
put it in a research note on Friday, “as we watch and wait, the market will be
anxiously aware that a sustained depreciation could have ramifications across
the globe by shifting the inflation dynamic at a most inopportune time.”
6. Tough times for Oz
Australia has
experienced an impressive economic boom in recent years on the back of selling
natural resources, including coal and iron ore, to its Asian neighbours, and
China accounts for more than a quarter of its exports. So weakness in the Chinese economy is bad news for Australia. Research by
consultancy Oxford Economics last week, which modelled the impact of a 10%
Chinese devaluation, accompanied by a sharp slowdown, suggested other hard-hit
countries could include Brazil, Russia, Chile and Korea.
7. Even more pain for Greece
If the Chinese
devaluation does bring what one City analyst, Albert Edwards, last week called
a “tidal wave of deflation” to the global economy, the most vulnerable
countries will be those that are heavily in debt – because while wages and
profits fall in a deflationary period, the value of debts remains fixed, making
them harder to service (to pay interest on). And economies where consumer
demand and confidence is already weak tend to be hit harder by the reduced
spending that deflation can bring. As economists at consultancy Fathom said
last week, “peripheral European economies”, not least crisis-hit Greece, fit
that definition. Greece is already suffering deflation after repeated cuts in
wages and benefits as the government tries to balance the books, and if it
worsens, that will only make its gargantuan debts – worth more than 170% of the
size of the economy – harder to service.
8.Currency Wars
Beijing’s move was
ostensibly offered as part of measures to open up its financial system, and
allow foreign exchange markets more say over the value of the yuan – something
America has long demanded as evidence that China is genuinely open to financial
reform. The International Monetary Fund described the move as welcome. But the
devaluation was nevertheless greeted angrily in Washington. New York senator Chuck Schumer said: “For years, China
has rigged the rules and played games with its currency, leaving American
workers out to dry. Rather than changing their ways, the Chinese
government seems to be doubling down.” Republican senator and former US trade
representative Rob Portman accused China of trying to gain an unfair trade
advantage over America though “currency manipulation” – just as the US is
negotiating an important trade agreement, the Trans-Pacific Partnership, with a
number of China’s rivals, including Japan.
If Beijing allows the yuan to decline further in coming months,
it could increase trade tensions, or even a “currency war”, in which the
world’s big trading blocs face off in a beggar-thy-neighbour battle to seize
the largest possible share of global consumer demand. For now, a 4% devaluation
in the yuan is more of a hairline crack in the world economic order than a
seismic shift; but policymakers will be weighing up its consequences long after
they return from their summer break.
Source:Heather Stewart.
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