After China unexpectedly devalued its currency last week, one London-based economist despairingly said: “It’s August.”
While it is meant to be a time for heading for the beach or kicking back in the sunshine with the kids, August has often witnessed the first cracks for what later become profound shifts in the global economy — from what former Northern Rock chief executive officer Adam Applegarth called “the day the world changed,” when the first ripples of the credit crunch were felt in 2007, to August 2011, when the US lost its “AAA” credit rating.
Last week’s devaluation, which left the yuan about 3 percent weaker against the US dollar, was relatively modest — the pound had lost 16 percent of its value in 1967 when then-British prime minister Harold Wilson sought to reassure the public about the “pound in your pocket.”
However, China’s decision represented the largest depreciation in 20 years, and the ripples might yet be felt thousands of kilometers away. What difference is it set to make to the rest of the world?
IT COULD BE SERIOUS
China’s devaluation might be best seen as a distress signal from Beijing policymakers, in which case the world’s second-largest economy might be far weaker than the 7 percent annual growth that official figures suggest. China has been trying to shift from export-led growth to an expansion based on consumer spending while trying to deflate a property bubble. Last week’s move, which loosened the yuan’s link to the US dollar, suggests some policymakers might be losing patience with that strategy and reaching for the familiar prop of a cheap currency.
Nobel prize-winning economist Paul Krugman described the decision as “the first bite of the cherry,” suggesting more could follow, and in a reference to Chinese President Xi Jinping (習近平), said that such a modest move gave the impression that, “when it comes to economic policy Xi-who-must-be-obeyed has no idea what he’s doing.”
If its economy really is much weaker than Beijing has let on, it would be alarming for any company hoping to export to China — something firms in Britain have been encouraged to do in recent years — to lessen reliance on stodgy European economies. China was the sixth-largest destination for British exports last year. China is set to remain a vast market, but it might not be quite such a one-way bet as some commentators have suggested.
In addition, when it comes to the challenges facing Chinese policymakers, “the potential for getting this wrong is quite high,” Llewellyn Consulting analyst Russell Jones said.
A CHEAPER CHRISTMAS
China has been trying to shift away from producing cut-price consumer goods for the rest of the world. However, the label on almost any T-shirt or toy — let alone consumer gadget — is still likely to read “made in China.”
A nation’s currency is not the only determinant of how much its goods cost when they reach the high street: Chinese wages have been rising, making its products less competitive and the price of raw materials and shipping is also important. However, the devalued yuan is set to force China’s Asian rivals, such as Indonesia and South Korea, to compete even harder, and the result might be a few cents off the price of Chinese-made Christmas presents.
“Almost 9 percent of the UK’s goods imports come from China, a share that has doubled over the last decade,” Oxford Economics analyst Martin Beck said.
So, there might be a direct disinflationary effect from cheaper imports.
China’s apparently insatiable demand for natural resources has been a key factor supporting the price of oil in recent years. Fears that China is in trouble tend to undermine oil prices — and that probably means cheaper gasoline. Of course, there are other factors, including strong oil production in the US, but global oil prices resumed their decline last week following China’s move, dipping back to less than US$50 per barrel. In coming months, weak Chinese demand could force down the cost of many commodities, from oil to iron ore.
DELAYED RATE RISES
Central bankers in the US and the UK have been issuing warnings for months that with growth strengthening, they are preparing to push up interest rates — reversing the emergency cuts made in the credit crunch.
Bank of England Governor Mark Carney has said “the turn of the year” might be the moment for a hike and US Federal Reserve Chair Janet Yellen has said that an increase could come as early as next month. However, if the cheaper yuan cuts the price of imports this would undermine inflation — which is already at zero in the UK — and could delay a rate rise. A renewed bout of market turbulence as global investors assess the implications of China’s decision could have the same effect.
In the short term, lower borrowing costs would benefit indebted consumers in the West — including Britain’s mortgage-holders. However, some analysts believe China’s decision is the latest evidence of a deep-seated lack of demand in the global economy, which is set to unleash deflation.
Brief periods of falling prices — particularly if concentrated among one or two commodities — can be good news; but economists fret about periods of persistently falling prices, which can undermine spending and investment and feed through to wages, as consumers and businesses delay spending, expecting goods to be even cheaper in future.
In addition, if a fresh downturn does come, central bankers have little ammunition left to tackle it, since interest rates in the US, the UK and Europe are already at rock bottom. Ann Pettifor, an economist at think tank Prime who foresaw the credit crunchin her 2006 book The Coming First World Debt Crisis, believes developed economies face some of the challenges felt by Japan during its “lost decade,” when it suffered both deflation and weak demand — but unlike Japan, many developed economies, not least the UK, would enter any new crisis under a heavy burden of debt.
Not everyone is so pessimistic, and Carney shrugs off the idea deflation is a threat in Britain; but as Bank of New York Mellon analyst Neil Mellor said in a research note on Friday, “as we watch and wait, the market will be anxiously aware that a sustained depreciation could have ramifications across the globe.”
TOUGH TIMES FOR AUSTRALIA
Australia has experienced an impressive boom in recent years on the back of selling natural resources — including coal and iron ore — to its Asian neighbors and China accounts for more than a quarter of its exports.
Weakness in the Chinese economy is bad news for Australia. Research by consultancy Oxford Economics last week, which modeled the impact of a 10 percent devaluation in the yuan accompanied by a sharp slowdown, suggested other hard-hit countries could include Brazil, Russia, Chile and Korea.
MORE PAIN FOR GREECE
If the Chinese devaluation does bring what London-based analyst Albert Edwards last week called a “tidal wave of deflation” to the global economy, the most vulnerable nations are set to be those that are heavily in debt — because, while wages and profits fall in a deflationary period, the value of debts remains fixed, making them harder to service (to pay interest on). In addition, economies where consumer demand and confidence is already weak tend to be hit harder by the reduced spending that deflation can bring. As economists at consultancy Fathom said last week, “peripheral European economies,” not least crisis-hit Greece, fit that definition.
Greece is already suffering deflation after repeated cuts in wages and benefits as the government tries to balance the books, and if it worsens, that would only make its gargantuan debts — worth more than 170 percent of the size of its economy — harder to service.
Beijing’s move was ostensibly offered as part of measures to open up its financial system and allow foreign exchange markets more control over the value of the yuan — something the US has long demanded as evidence that China is genuinely open to financial reform. The IMF described the move as welcome. However, the devaluation was nevertheless greeted angrily in Washington.
“For years, China has rigged the rules and played games with its currency, leaving American workers out to dry. Rather than changing their ways, the Chinese government seems to be doubling down,” US Senator Chuck Schumer said.
US Senator Rob Portman accused China of trying to gain an unfair trade advantage over the US through “currency manipulation” — just as the US is negotiating an important trade agreement with a number of China’s rivals, including Japan.
If Beijing allows the yuan to decline further in coming months, it could increase trade tensions or even cause a “currency war,” in which the world’s big trading blocs face off in a beggar-thy-neighbor battle to seize the largest possible share of global consumer demand.
For now, the devaluation in the yuan is more of a hairline crack in the world economic order than a seismic shift; but policymakers will be weighing up its consequences long after they return from their summer break.
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