Will China Join in the Currency Devaluation War?

Fifteen years ago, with the spread of the financial crisis in East Asia, Russia and Brazil fell into the global financial crisis, and many emerging economies have been to devalue its currency. However, the Chinese government pledged not to depreciate the yuan and earned plaudits as a responsible power. Currently, the United States, Europe and Japan initiate a new round of currency devaluation after their respective quantitative easing monetary policy.

Previously, Yi Gang, deputy governor of the People's Bank of China (PBOC), said that the RMB exchange rate is not far from the equilibrium. To some extent, this statement can regarded as an "attitude" but not the clear "position" expression to not to devalue the RMB.

On April 12, the U.S. Treasury announced the report on international economic and exchange rate policy for its main trade partners. The report shows that all the major trading partners including China did not manipulate currency exchange rate for an unfair trade advantage while warning Japan to refrain from the yen "competitive devaluation" policy.

On April 13, U.S. Secretary of State John Kerry made a trip to China as invited. Though Kerry’s trip put focus on the peace of Korean Peninsula, RMB began sharply appreciation for four consecutive days after the end of this trip, higher than the whole appreciation of last year. Yet, this clearly showed China’s position on RMB exchange rate—stabilizing the market expectation of RMB. Instead of implement "competitive devaluation" policy, the related authority in China would appreciate RMB rather than indulging its depreciation to avoid depreciation expectation.

However, it is outright exaggerated that Chinese government commit to not devalue RMB in any case. In fact, RMB may devalue only if there were no depreciation expectations.

On April 17, Yi Gang said in Washington that China highly concerned about the possibility of competitive devaluation and the related negative impact. Also, he pointed out that the yuan’s trading band will be widened “in the near future”. Obviously, China's foreign exchange authorities feel the enormous pressure from competitive devaluation, and they know they can’t resist such external shock by appreciate RMB. However, greater exchange rate fluctuation range enlarges the currency market risk, and there are different predicts about exchange rate limits increase. Till now, there’s no official notification. To some extent, it can be regarded as the stern warning to the potential hot money that may pour into China.

China has the world's largest foreign exchange reserves, which equals to the total GDP of Germany. One-third of them are used to buy US Treasuries. With the strong appreciation of RMB against US dollar, China’s huge reserves are stuck in a dilemma. Whether appreciation or depreciation, there would be harm to China’s economy. That’s why Yi stated the exchange rate of RMB was near the equilibrium.

Yet, “the appropriate exchange rate” shows the fragile price range of RMB. With huge foreign exchange reserves and stiff foreign exchange management system, there’s little room for the flexibility of RMB. Even after the monetary authority’s commitment of no devaluation, it can’t help much to stabilize the RMB expectation. Expanding Yuan’s floating band is just to release pressures but does not eliminate it.

Since the exchange rate reform, the RMB has been subjected to the appreciation pressure. However, it has never been tortured by the depreciation pressure. In my opinion, the threat to the stability of RMB probably comes from the depreciation expectation, which will directly lead to an outflow of capital.

In the turbulence between global currencies war, there will be more international capital to pour into China to gain benefits with its commitment to no devaluation. However, China does not have the tunnel to export inflation. As a result, the yuan-dollar exchange rates will soar, and China’s foreign reserves will become much bigger. With the slowdown of economic growth and the booming government debts, it’s more difficult to deal with China’s foreign reserves; considering the strong shock of other currencies’ devaluations, challenges faced by China’s foreign exchange authorities are increasingly difficult.

Originally published on Reuters China | 2013-4-24