Who's Afraid of a Falling Yuan?
Everyone from buttoned-down Japanese central bankers to ex-slugger Jose Canseco (or whoever hacked his Twitter account) seems to be worried about the sliding value of China's currency, the yuan. The fear is that a cheaper yuan will spur other export-dependent countries to devalue as well in order to remain competitive, sparking a global currency war. Meanwhile, ordinary Chinese will presumably race to move their money out of the country and Chinese companies will struggle to pay back loans taken out in dollars. A truly uncontrolled dive threatens to cause havoc throughout China's opaque financial system.
Such fears are overblown. The true impact of a falling yuan is likely to be both more nuanced and more limited in nature.
At the most basic level, a falling currency raises the prices of imported goods and lowers the prices of exported goods. Demand for and consumption of imports should decline as they become more expensive, while exports receive a boost. That's the model China used for decades to power its economic boom. Most other countries, including the U.S., have traditionally favored a strong currency that raises the domestic standard of living vis-a-vis the rest of the world.
China, too, says it now favors a stable yuan and has been spending billions each month to buy up the currency to bolster its value. There would appear to be two dangers: first, that the effort fails in the face of concerted downward pressure from the markets; or second, that China itself decides to devalue in order to revive its export-focused manufacturing sector.
Yet how bad would that really be? Chinese companies are moving quickly to pay off or restructure their dollar loans. As for consumers, it's important to remember that large countries such as China trade less than small countries in relative terms. Thus they're better insulated against a rise in the price of imports. (Imports comprise only about a fifth of Chinese GDP.)
Additionally, not all the products countries import are equally price-sensitive. Machinery, metals, minerals and chemicals make up about 60 percent of Chinese imports. Add in precision equipment such as watches and medical devices, precious metals, transport and rubber products and the proportion rises to nearly 90 percent. Price affects but doesn't finally determine demand for most of these goods. Chinese commodity imports are likely to continue declining, but more because of the overcapacity created by a surge in investment after the 2008 global financial crisis, rather than anything to do with the yuan.
The sheer volume of Chinese exports means the country does have an outsized impact on world markets. Yet Chinese exports remain dominated by electronics and garments. Base metal processing and miscellaneous manufacturing bring the proportion up to almost 70 percent of total exports. These are, despite talk of moving up the value chain, still low-wage and low-skill sectors.
The countries that will feel the most pain -- low-wage nations such as Bangladesh, Vietnam and Indonesia -- represent a relatively limited subset of the global economy. While China's recently raised its share of global clothing exports at their expense, the world's biggest economies have much less to fear.
The latter no longer make the kind of basic manufactured goods that dominate Chinese exports, at least not in large quantities. To take one example, China received $459 per ton of exported steel in December but paid $1,023 per imported ton. Why the difference? China is exporting low-quality steel but importing more valuable, specialty products. Japan, the U.S. and South Korea hold dominant positions in the latter fields.
Nor would a falling yuan necessarily generate a wave of global deflation. Core price deflation in areas such as energy, commodities, and food has more to do with increased productivity and overinvestment outside of China than it does with yuan policy. If declines in the dollar after the 2008 crisis and the yen more recently didn't spur worldwide deflation, there's no reason to think a fall in the yuan would now.
Before worrying about what China does or doesn't do with its currency, other countries should set their own houses in order. After 2008, the world economy revived on the back of a Chinese construction boom that drove up commodity prices and investment. Now that China's slowdown has been evident for at least a year, companies would be well advised to start planning for a "new normal" of slower growth and investment, as well as a moderately weaker yuan.
If the rest of the world wants China to join the global economy, they have to be willing to treat the country the same as any other. It's a bit rich for nations such as Japan, which has allowed the yen to plummet against the dollar, to suggest that China should impose hard capital controls to prevent the yuan from sliding. If the market thinks the Chinese currency is overvalued, it should be allowed to find its fair level. It won't be the end of the world.
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