A Cheaper Yuan Won't Help China
Fears that China may spark a currency war by devaluing its currency have hammered stocks both at home and abroad, helping to send the Shanghai bourse into bear territory. That's only one reason Chinese leaders should think twice about driving down the yuan, though. The other is that it probably won't work.
The common wisdom is that a cheaper currency helps exports. Holding all else constant, as economists are wont to do, lower prices should increase demand for Chinese goods, giving a fillip to an economy that's now growing at its slowest rate in a quarter century. But there are many reasons to believe that devaluing the yuan won't kick-start growth in China and may cause bigger problems down the line.
First, exports make up a much smaller portion of the economy than they have in China's modern history -- only 22.6 percent of GDP at the end of 2014, a proportion that shrunk further in 2015. Even a large jump in exports would thus have a relatively modest impact on GDP growth: Bloomberg Intelligence has estimated that a drop in the yuan’s exchange rate from 6.58 to 7.7 to the dollar would add only 0.7 percent to GDP. A cheaper currency also raises the price of imports -- a poor signal to send if China truly wants to transition to a consumption-driven economy.
Furthermore, given how integrated China is into modern global supply chains, a fair amount of its trade now relies on imported components or is processing trade. A devalued currency would make many inputs -- including those that go into the millions of iPhones assembled on the mainland -- more expensive, further dampening any expected boost to exports.
Nor would a lower yuan help energize Chinese processing trade, given the minimal amount of value that stays in the country. One study found that only about three percent of an iPhone's value remains in China, a portion sure to be unchanged by a fluctuating currency. One IMF study found that “global value chains” reduced currencies' ability to increase trade by 22 percent on average, more for some countries.
Finally, given the sizeable depreciation of other emerging market currencies against the dollar, it would take a fairly significant decline in the yuan to stimulate trade and growth. China has become an expensive place to do business, losing its low-cost mantle to Southeast Asian countries such as Vietnam; a small devaluation won't be enough to draw back customers who’ve left recently. Only an unpalatably large decline would restore Chinese cost-competitiveness.
All this begs the question of whether China should even want to return to a growth model of running large surpluses based upon a cheap currency. Certainly, for the Chinese regime, devaluing the yuan must look politically more palatable than shutting down companies or blocking loan rollovers: It would impose costs on other countries rather than on the domestic population. But that growth model has hit its limits. Returning to it would only be an excuse to avoid the difficult reforms needed to fuel competitiveness and dynamism.
Indeed, what's really driving downward pressure on the yuan are capital outflows as Chinese investors look to get their money out of the country into safer havens such as the U.S.; by some estimates, $1 trillion has left China since the middle of 2014. One can hardly blame them. Despite the regime's promises, economic growth remains weak and surplus capacity prevents new projects from getting started. Access to capital for everyone but state-owned enterprises is difficult at best. Domestic companies are reluctant to invest in new products given China's weak record on intellectual property rights.
Chinese investors don't trust the regulatory structure to protect them and fear advertising their wealth, lest they attract the attention of the regime's anti-graft investigators. Meanwhile, foreign investors feel targeted by inconsistent investigations and opaque laws; they're not about to fill the void left by fleeing Chinese capital.
Not only would devaluing the yuan do little to boost growth, it runs the very real risk of sparking additional capital outflows as investors seek to preempt future declines. More importantly, it would do nothing to help build a healthier, more innovative economy.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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