Is China undertaking a stealth devaluation ahead of the US election?

Devaluing the yuan well ahead of January’s inauguration of the next US president is sensible given the growing tensions over trade

PUBLISHED : Tuesday, 12 July, 2016, 10:08am
UPDATED : Tuesday, 12 July, 2016, 10:45pm

Timing is everything. Last December’s decision by China to target the yuan’s value on a basket basis has proved a boon for Chinese exporters, giving Beijing flexibility to guide the yuan amid global uncertainties prompted by last month’s decision by British voters that the United Kingdom should leave the European Union.

Unease surrounding that Brexit decision has led to capital flows into many Asian currencies evidenced in part by their subsequent rise versus the dollar.

In contrast, with Beijing focusing on the value of the China Foreign Exchange Trade System’s (CFETS) yuan index, the appreciation of China’s currency against the euro and the pound, in the same period, was offset by its weakening against the US dollar.

Other nations in Asia have not enjoyed such an offset.

Policymakers in China may have concluded ... a fall in the value of the yuan versus the dollar in coming months might anyway be advantageous

This can be illustrated by a look at the way the yuan performed in the week before and after the June 23 Brexit referendum as compared to the performance of other Asian currencies over the same time frame.

On June 17, six days before Britain voted, the CFETS yuan index was 95.82 falling to 95.29 on June 24, the day the Brexit result was announced, before falling again to 95.02 on June 30 . The yuan fell against the basket of targeted currencies.

And yet, between June 17 and June 30, the yuan rose to 8.90 to the British pound from below 9.40 while also posting some marginal gain versus the euro.

The apparent discrepancy is essentially accounted for by a fall in the yuan versus the dollar, whose dominant weighting in the CFETS index dwarfs that of sterling. During the period in question the daily fixing for the dollar/yuan exchange rate rose to 6.6312 on June 30 from 6.5795 on June 17 .

That June slip in the yuan’s value versus the dollar not only more than cancelled out, in index terms, the yuan’s rise versus sterling, it simultaneously underpinned the exchange-rate competitiveness of China’s exports to the United States.

Of course the uncertainty that ensued from the Brexit vote did drive capital into the safe haven of US Treasuries and might therefore be a source of general dollar demand which spilled over into the dollar/yuan exchange rate rise.

If so then that dollar strength should also have been expected among other Asian currencies, but that wasn’t the case.

As one might expect, sterling’s post-referendum fall from grace was broad-based leading to substantial rises in the value of the Japanese yen, the South Korean won, the Singapore dollar and the Taiwan dollar versus the pound.

Those same Asian currencies also performed well versus the euro in the period of June 17-30 in question but none replicated the yuan’s weakness versus the dollar. Indeed the yen and the won, in particular, strengthened against the greenback.

That also meant that in intra-Asia terms, during that period, the yuan weakened against the yen, the won, the Singapore dollar and the Taiwan dollar to give China’s exporters an additional degree of currency comfort during that initial time of Brexit-induced global economic uncertainty.

Of course China’s neighbours will likely be unimpressed by the turn of events. Some might argue that Beijing has guided the yuan weaker using Brexit as camouflage, though Japan for one can hardly cry foul when the policy mix in Tokyo in recent years resulted in a massive if now partly reversed slide in the yen’s value.

But perhaps China’s deft currency basket management is more than just a response to events that have occurred in Europe.

Policymakers in China may have concluded that even while the Brexit vote has been a catalyst for wider currency moves that required close attention, a fall in the value of the yuan versus the dollar in coming months might anyway be advantageous.

Indeed the yuan’s fall versus the dollar has continued with China’s currency fixed at 6.6853 to the greenback last Friday.

No one knows who will be the next US president. However both the likely candidates have talked tough towards China but must also, surely, know that Beijing and Washington need a good economic working relationship.

If Beijing was considering that some degree of yuan strength after January’s inauguration of a new US President would be diplomatically expedient, it would make perfect sense to weaken the yuan versus the dollar ahead of time.

That might sound Machiavellian and its neighbours in Asia might not like it but China’s currency basket-weaving since the Brexit vote represents a logical self-interested response to that situation.

The index-linked approach that China has adopted towards the yuan has arguably given Beijing the flexibility in its currency management that China’s neighbours can only dream of.