12 Aug 2015

China: danger of an open currency war

China has stunned the world by devaluing its currency twice in two days. Or rather it has stunned that naive part of the world that believed China’s economy was okay, that its Communist Party was en route to being some kind of team player in the global economy, and that the words “currency war” were just scaremongering.


Here’s what’s happened, and why it matters. China’s economy, which grew at 9 per cent and above per year in the period of rapid industrialisation in the 2000s, has slowed to 7 per cent.
Because the entire control system of the conomy is based on one bureaucrat lying to/competing with another, nobody really knows whether the Chinese growth figures are correct – but there’s been a clear slowdown.

That, in turn, caused a stock market slump last month – after more than a year of ordinary Chinese people pouring money into shares. So the government tried to contain by ordering state owned stockbrokers to buy RMB 120bn worth of shares, setting a stock market “target level” reminiscent of the old Soviet grain targets.

Now, with growth continuing to falter, the Chinese government has devalued its own currency again in a bid to boost exports. At the same time – as a concession to its trade rivals – it has promised to “take more notice of the markets” when setting interest rates in future.

Since it re-entered the global economy, China has pegged its currency, the renminbi, against the dollar – refusing to let it trade freely and to find a market rate. Under pressure from America and Japan, which say China’s currency is too cheap and gives it an unfair trade advantage, China allowed the RMB gradually to rise against other currencies. This was seen as a first step towards the RMB becoming convertible, and ultimately emerging as a rival global currency to the dollar.

Now that policy has been reversed. The context is, first, the tit-for-tat stimulus measures that the world’s major economies have been taking. Europe has launched a massive programme of quantitative easing; Britain’s QE programme remains in place and Japan is reliant on more and more dollops of printed money to buy state debt and keep the economy going.

When states or currency unions print money on this scale the side effect is to weaken the value of their currency and boost exports. So another way of looking at QE is as an undeclared currency war – which is exactly how China sees it.

The complication is the USA: the USA has just ended its QE programme, so the dollar is soaring. Because the RMB is pegged to the dollar, that was forcing the Chinese currency upwards at a time it needs it to go downwards.

If we survey the whole developed world, plus China and Russia, we see a picture of states using currency tactics effectively to steal growth from each other. If you add to that the recent collapse of oil prices, it adds to powerful deflationary forces that pessimists always feared would emerge in the world economy as the stimulus after the 2008 crisis either runs out or is unwound.

Basically, if – like me – you fear de-globalisation as a result of the failure to tackle the strategic problems that lay behind the 2008 crisis, this is just China sticking to the script.

But the wildcard, as always, is the Chinese people. The communist government sits – Canute like – ordering the stock market to rise because it knows the young Chinese populace is so well connected, informed and educated now that only a combination of repressive action (for example last month’s round up of human rights lawyers) and perpetual stock-market boom will stave off political discontent.

And there is nothing like a massive tactical devaluation of your currency to give your economy breathing space. The danger is now of an open currency war – where states stop pretending loose monetary policy is only devaluing their currencies “accidentally” and positively embrace the logic of competitive devaluation.

Currency wars always leave the last country to act facing stagnation – and until 2015 it was the eurozone, which had refused to do QE on the grounds it was “against the rules”.

If things remain as they are, the most likely outcome will be a slowdown in the USA (which has just finished QE) – creating huge pressure on Congress and the presidential candidates – to take retaliatory measures.

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