Why did China devalue its currency?
But did the Renminbi really devalue?
We first need to step back and expand the timeframe.
Here is a chart of the RMB vs. the U.S. Dollar since 2003 (the chart going up signals depreciation):
From this chart it is pretty straightforward to see:
For a long time (a) the RMB was fixed at around 8.3 against the U.S. Dollar.
In mid-2005 (b), the People’s Bank of China (PBOC) changed policy (under fairly intense political pressure) and started allowing the RMB to gradually appreciate …
… until it reached 6.8 on the eve of the Global Financial Crisis (c), at which point it paused.
Then, in mid-2010 (d) with the world economy starting to recover, the PBOC began allowing the RMB appreciate again …
… reaching an all-time peak at the beginning of 2014 (e) close to 6.0.
Since that point, movements against the dollar have been more volatile, including the abrupt “one-time” devaluation last August (f).
Today, the RMB has fallen back to around 6.6.
If your timeframe is the last two years (i.e. since the beginning of 2014), then yeah, technically the RMB has devalued against the U.S. Dollar. But if your perspective is anything longer than that, then it has really in fact appreciated.
Now, let’s flip the script and look at the RMB against the Euro. Here, we have a somewhat different picture:
While the RMB was appreciating against the U.S. Dollar from 2005 to 2008, it was actually depreciating (a) against the Euro …
… reaching a nadir of 11 to the Euro (b) in early 2008. This is because the U.S. Dollar was depreciating at a faster pace against the Euro, more than offsetting the RMB’s gradual appreciation against the U.S. Dollar.
Following the Global Financial Crisis, the RMB with some volatility appreciated against the Euro, eventually settling (c) around 8.0 RMB to the Euro.
Then in 2014 (d), the head of the European Central Bank, Mario Draghi, starts signalling plans to put into effect a massive quantitative easing program to help the struggling Eurozone economy.
This effectively crashes the Euro against the U.S. Dollar and, via the transitive property, the RMB. The RMB abruptly strengthens to as much as 6.7 (e) vs. the Euro.
Today, it trades at 7.2 (f).
From the perspective of the Euro, the RMB has appreciated almost 50% over the last 8 years, including 20% just in the past 24 months. Today, the RMB is actually trading less than 7% from all-time highs versus the Euro.
And this is meaningful, because the Eurozone happens to be China’s largest trading partner:
If you ask a Chinese exporter whose largest customers are in the Eurozone whether things are getting better now that the RMB is “devaluing”, he would fall to the floor laughing hysterically.
Not only has he had to deal with wages that have been rising at double-digit percentage points every year, to add injury to insult, he has seen his costs measured in Euros skyrocket an incremental 50% since 2008 due to currency appreciation. There are very few businesses out there would remain profitable if your costs doubled over a five-year period.
P.S. I won’t go through the RMB to Japanese Yen chart, but essentially the same story has played out there with China’s third-largest trading partner as well.
Long-term Perspective
China is in a very, very long and gradual process of reforming and liberalizing nearly everything, including its currency.
Throughout this process, it has had to balance the needs of consumers (who benefit from a stronger currency) with the needs of its exporters (who create jobs and benefit from a weaker currency). It has had to balance the merits of providing a stable macro environment (through strict capital controls, currency pegs, etc.) with the merits of letting market forces control price movements (greater volatility, but better response to real-time needs). It has had to do this in the wake of oftentimes intense diplomatic pressure from its largest trading partners.
When China’s PBOC let the RMB suddenly drop by 2% against the U.S. Dollar last August, this move came at around the same time as the announcement to move off a tight peg against the U.S. Dollar and instead trade against a basket of currencies that better represented its actual trading relationships.
This is a very sensible move and one that moves them another small step closer towards having a true market-based system. The IMF more or less endorsed this by announcing the inclusion of the RMB in its Special Drawing Rights (SDR) basket. Since then, the RMB has depreciated modestly further against the U.S. Dollar which I view as “catch-up” devaluation to counter the abrupt 20%+ depreciation of the Euro in 2014-2015.
For Chinese exporters, perhaps this is a signal that their close to decade-long struggle fighting against currency headwinds is coming to an end. China is trying to make domestic consumption the principal driver of growth going forward, but it is not by any stretch of the imagination abandoning its exporters.
The export industry has continued to grow despite these currency tailwinds, and today is more than 60% larger than it was in 2008. Export-oriented manufacturing still provides direct employment for close to 30 million workers, and indirect employment to tens of millions more, especially as Chinese exporters gradually climb up the value chain.
The other thing that gave the PBOC breathing room to push this forward were low oil prices. Theoretically, one of the negatives of devaluing your currency is that it becomes more expensive (in domestic currency terms) to purchase imported commodities like oil. However, given the >70% drop in crude oil prices, China is spending a hundred billions or so dollars less to meet their import bills. This is more than enough consumer stimulus to offset the effects of a measly 5-6% devaluation.
This was originally published on Quora in January 2016.