China's Devaluation Jolts Global Markets

At the Wall Street Journal, "China’s Devaluation of Yuan Jolts Global Markets: Greece and Its Creditors Agree Terms for a Third Bailout, But Some Details Remain Unresolved."

Also, "China Moves to Devalue Yuan":

BEIJING—China’s central bank devalued its tightly controlled currency, causing its biggest one-day loss in two decades, as the world’s second-largest economy continues to sputter.

Chinese authorities said the change would help drive the currency toward more market-driven movements. The move also signaled the government’s growing worry about slow growth. A shift toward a weaker currency could help flagging exports at a time when many other efforts to boost the economy haven’t proven very effective.

China’s yuan has been on an upward track for a decade, during which the country’s economy grew to be the second largest in the world and the currency gained importance globally. The devaluation Tuesday was the most significant downward adjustment to the yuan since 1994, when as part of a break from Communist state planning, Beijing let the currency fall by one-third.

China sets a midpoint for the value of the yuan against the U.S. dollar. In daily trading, the yuan is allowed to move 2% above or below that midpoint, which is called the daily fixing. But the central bank sometimes ignores the daily moves, at times setting the fixing so that the yuan is stronger against the dollar a day after the market has indicated it should be weaker.

With Tuesday’s move, the fixing will now be based on how the yuan closes in the previous trading session. As a result, the yuan’s fixing was weakened by 1.9% Tuesday from the previous day, leaving it at 6.2298 to the U.S. dollar, compared with 6.1162 on Monday. The yuan dropped as much as 1.99% from its previous close to 6.3360 against the dollar in Shanghai and fell as much as 2.3% in Hong Kong in early trading.

The central bank said in a statement posted on its website that the yuan’s midpoint has diverged quite a bit from the market rate for a relatively long time and that it was time to make the midpoint more market-based.

“The PBOC has astutely combined a move to weaken the yuan with a shift to a more market-determined exchange rate,” said Eswar Prasad, a Cornell University professor and former China head of the International Monetary Fund.

China’s leadership has been urging the IMF to declare the yuan an official reserve currency on par with the dollar, euro, the Japanese yen and the British pound—a move that could raise China’s influence on the world stage just as Beijing increasingly challenges Washington in global affairs.

To that end, the leadership has been resisting an outright devaluation of the currency despite the country’s plunging exports, for fears that a move like that could jeopardize the yuan’s chance of joining the elite group of currencies.

Rather, it chose to do so by giving what the longtime critics of China’s currency policy have long been clamoring for: Let the market play a bigger role in deciding the yuan’s value.

This is literally the highest stakes in the international political economy. The leading great power, the U.S., enjoys enormous privileges with the dollar as the world's reserve currency. Clearly, China would like to knock the U.S. off its pedestal. But the yuan's collapse is showing just how unstable the Chinese economy is.

More.

See also, "China Currency Devaluation Another Sign of Growth Worries":

In the U.S. movie “The Wizard of Oz,” a mythical figure purported to have great powers suddenly loses his mystique when he is revealed to be no more than an aging silver-haired man pulling levers of a clunky oversized contraption behind a curtain. There is something happening in China which has a Wizard of Oz quality to it right now.

Chinese authorities awed the world during the 2007-2009 global financial crisis when they kept their economy growing at superfast speeds even when the rest of the world was nearing economic collapse. It seemed to be confirmation, after years of growth rates that allowed China to leap past rivals and become the world’s second-largest economy, that the Middle Kingdom and its leaders were special. Now, as the growth rate slows, the levers aren’t working very well and the image is losing its aura.

Chinese authorities on Tuesday effectively devalued the yuan by 2%. As currency devaluations go this was small. In 1994 China let its currency fall by a third, helping to breathe new life into an export explosion. Officials said this latest move was meant to allow the carefully managed currency move more in line with market forces. Yet it looked like a new step – albeit a small one -- by officials to boost flagging economic growth. A weaker currency might help boost exports by making them cheaper. On Saturday the government reported that exports fell 8.3% in July from a year earlier.

While a weaker currency might help exports on the margin (and also annoy China’s trading rivals) it doesn’t fix China’s underlying economic problems. The country’s economy appears to be suffering from the depleting after-effects of not one but three asset booms – an investment boom in industrial capacity which is weighing on global goods prices, a real estate boom which may have stretched domestic banks and more recently a stock market bubble.

Adjustments from bubbles rarely go smoothly and they almost always sap some economic vitality. As the wizard says in the movie, pay no attention to that man behind the curtain.