Last month, China devalued its currency, slightly lowering the bottom of the range within which market forces can determine the yuan’s foreign exchange value. The central bank’s announcement triggered severe repercussions in global financial markets—but it was inaccurate and incomplete.
The statement from the People’s Bank of China (PBOC) hinted that the yuan—also known as the renminbi (RMB), literally “people’s currency”—is likely to lose more value in the coming months. Strictly speaking, “devaluation” signifies movement from a higher pegged exchange rate to a lower, equally pegged rate. With the announcement foreshadowing gradual movement toward a lower foreign exchange value for the RMB, it’s more accurate to characterize it as depreciation.
Even more indicative is what the disclosure left out. While acknowledging the underlying aims of offsetting GDP growth slowdown and boosting exports, the PBOC omitted any mention of other significant, if complicated, motives behind the depreciation.
Prominent among these goals is China’s aspiration for the RMB to become an international reserve currency, along with the dollar and, to a lesser extent, the euro. With this aim comes the quintessential requirement that a reserve currency be freely convertible into other currencies—that is, freely “floating” in value relative to other currencies—rather than selectively convertible and partly blocked from conversion into other currencies, which is the RMB’s present status. The RMB is readily convertible for companies, investors, and individuals that the PBOC and the State Administration of Foreign Exchange view as “approved” and “reliable.” Examples include Alibaba, Hua Wei, ZTE, Lenovo, and other brand-name Chinese companies, plus China’s state-owned enterprises, such as the China National Offshore Oil Corporation, the China Chemical Company, and the China Petrochemical Corporation. “Approved” and “reliable” individuals include Zhang Xin, China’s billionaire real estate developer, and a few others in the field (“reliable” includes a presumption that those so characterized will earn and transmit back to China sufficient dollars to overcompensate for their prior dollar investments). For other holders of RMB currency deposits, convertibility is often delayed, time-consuming, and uncertain. This large-scale government-managed convertibility is inconsistent with the freely floating convertibility of a global reserve currency.
The bank hoped the depreciation would be seen as moving the RMB closer to its “true” (or “equilibrium”) range in foreign exchange markets. China seemingly prefers that this appraisal be arrived at through a smoothly paced process in which market forces are “guided” by the PBOC rather than allowed to operate freely, which would make the currency prone to volatility. This preference is unrealistic and self-contradictory.
Another possible motive was countering the sharp downturn in the Shenzhen and Shanghai securities markets using the indirect instruments of monetary policy favored by the central bank, including expanding the money supply through gradual currency depreciation. But other members of the top leadership preferred and immediately invoked more direct and blunt instruments by suspending trading, disallowing short-sales, and making direct government purchases of vulnerable equities to counter the markets’ precipitous fall.
Other salient aims of currency depreciation relate to key components of China’s inflow and outflow of capital. On one hand, China’s large (yet perhaps underestimated) GDP slowdown might be alleviated by foreign direct investment in China (capital inflow). On the other hand, GDP growth might be enhanced by Chinese companies’ or individual investors’ acquisition of higher-yielding foreign companies and equities (capital outflow). If and as gradual depreciation proceeds to a reasonably stable range, an appropriate balance between the two capital flows may ensue.
I conjecture that a “reasonably stable range” for the RMB’s foreign exchange value is likely to lie between 7 and 8 RMB per U.S. dollar (1 RMB=13-14 U.S. cents), rather than 5-6 RMB per dollar (17-20 cents); today, its foreign exchange value is 6.4 per dollar (15.6 cents). Several congressional leaders and a few presidential candidates have argued—and sometimes continue to argue—that China’s currency was undervalued, not overvalued. I’d opine instead that the RMB was and is overvalued, warranting depreciation, not appreciation.