Beijing's currency bazooka will only backfire

With a dramatic devaluation of the yuan yesterday, Beijing brought out the bazookas in a move that might escalate a regional currency war that it had until now chosen to avoid.

SCMP, August 12

Let's get that bazooka bit straightened out first. The bazooka was a low velocity anti-tank weapon of the second world war. It delighted the comic strip artists. It gave them opportunity to write KA-BOOM! in big letters. It disappointed the soldiers. It was soon abandoned.

I'm not sure this Beijing bazooka will be much more effective.

The idea, I suppose, is the old one that your exports are more competitive if your currency is soft against the US dollar. Thus when your export growth is down, you devalue your currency and, presto, your exports go up again. Any magician can tell you how it works.

But it only really works if a significant proportion of your costs are incurred in your local currency and this proportion is so small in the mainland that it only publishes its trade statistics in US dollar terms. Why do it in yuan? It's a US dollar business. Everyone knows this even if the magician does not.

One statistic, for instance, that has long bounced around is that the yuan cost element of an Apple iPhone is only about 5 per cent of its retail price. All the rest is imported component or transacted elsewhere.

The mainland is the assembly station, not much more. This is what the container revolution has done, made possible the fragmentation of consumer goods manufacture to an extent never before imagined.

But even where the difference in wage costs could make a difference in export competitiveness, it often has not.

You might expect this wage-sensitive export business to move into India as a result but, no.

China's textile and garment exports at present run at about US$300 billion a year, India's at about US$35 billion, and India is not short of workers. Export success is not built on local currency cost alone.

The big determining factor at the moment is a simple one. If people don't want to buy, then you will have trouble selling.

As the second chart shows, the big markets of Europe and America don't want to buy just now. Import growth has turned decidedly negative.

But, as the chart also shows, Chinese export growth (adjusted here for a Lunar New Year holiday aberration) is still in positive territory and well above the average of the rest of Asia. China is still gaining market share.

I rather think this bazooka will backfire (in fact how the real one was designed to operate). The devaluation will defer hopes of making the yuan a world reserve currency, it will impair relations with the US, it will further encourage capital flight, and it will fuel inflation.

Ka-boom indeed.