China’s yuan devaluation reignites fears of ‘currency war’

As China takes bold steps to depreciate its currency, competition rises on global financial battlefield, Fed’s September rate hike seen as less likely

Photo by: Reuters
Photo by: Reuters

Updated Aug 14, 2015

China shocked global markets by devaluing its currency three consecutive times within three days by 1.9 percent, 1.6 percent and 1.1 percent respectively. On the third day, Thursday, the People’s Bank of China (PBOC) stated that there was no basis for further depreciation in the yuan given strong economic fundamentals.

However, analysts believe that more devaluation might come from the central bank as the world’s second largest economy is trying to boost its slowing exports and raise competitiveness.

Upon the move, shares of Chinese export companies jumped sharply, while other company shares, commodities and the rest of the world didn’t react well to the yuan’s devaluation, which has been the highest in the last 20 years. Also, fears of “currency war” was reignited.  

But, what’s a currency war? In cases when easing policies and printing money don’t have the required effect on creating inflation and boosting domestic demand to revive growth, countries choose to grow on exports. And the easiest way to increase exports is to devalue the country’s currency. Since all countries are in a race to have the “invaluable” currency, basically they are forwarding their problems to others on the financial battlefield.

Japan sets one of the most historic examples for this and is a never ending member of the “currency war.” The country took bold and unprecedented steps to devalue its currency against the dollar in order to get off years long deflation.

In April 2013 the Bank of Japan (BOJ) launched a monumental monetary stimulus aimed at reviving the country’s stalling economy and create inflation. Additionally, the bank injected another stimulus of $700 billion in October 2014.

In 2014 the yen fell 16 percent against the dollar and although it takes time for devaluation to reflect on trade figures, Japanese exports gained momentum last year.

Thus, Japanese economy expanded by 2.4 percent in the first quarter of 2015, a much higher result than the market expectation of 1.5 percent.

Japan has benefited from the “currency war”, but Swiss National Bank (SNB) is considered to be the first “loser” of this financial battle. At the peak of the eurozone financial crisis in 2011, the SNB introduced 1.20 francs per euro cap to fight off deflation and recession.

However on January 15, 2015 the SNB took a big U-turn and announced that it scrapped off the cap on the franc. Upon the announcement the Swiss franc gained sharply against the euro. On social media, the central bank’s step was called “Francogeddon”, a move which directly affected Swiss export firms, luxury and tourism industries.

Then in late June, the SNB made a rare announcement and said it intervened in foreign exchange markets to weaken the franc’s rise after Greece imposed capital controls and closed the country's banks.

On the other hand, there is a divergence between eurozone countries whether to have a strong or weak euro. Unlike weaker economies in the eurozone, Germany demands stronger currency, while the others would like to have weaker euro in order to be able to reconcile their debt much easier.

Also trying to fight of deflationary risks, the European Central Bank (ECB) initiated a quantitative easing programme, which is scheduled to end on September 2016, buying €60 billion a month. This move has been strongly opposed by Germany, since injecting money depreciates the single currency.

Additionally, China’s recent move is at the same time a friendly reminder to the new period, which is going to start with the US Federal Reserve’s monetary tightening. The Fed is expected to raise its interest rates for the first time in 9 years. However, there are concerns that higher US policy rates might cause financial instability in the US and beyond its borders.

Higher interest rates equal to the dollar’s journey back to its homeland and stronger dollar. Although emerging markets are expected to get influenced by this the most, US companies will not benefit from a strong US currency.

The dollar has been on the rise for four years and if the Fed will raise its interest rates in September, it’s expected to gain even further value. According to analysts, strong dollar can be the only burden which would stand in the way for a rate hike.

While almost all of the US’ global competitors are weakening their currencies, there is a question on how the Fed would hike rates and strengthen its currency. With China’s move to devalue its currency just before the Fed is expected to strengthen its monetary policy and the US dollar, global markets started to speculate that the Fed might not hike rates in September.

The US benchmark 10-year note fell, while the dollar declined more than one percent against a basket of currencies and also declined nearly one percent against the Chinese yuan on Thursday.


TRTWorld and agencies