Thursday, 10 September 2015

How China’s Yuan Devaluation Affects Us All

After China unexpectedly devalued its currency last week, City analysts shrugged and said: “It’s August.” But China’s move represented the largest yuan depreciation for 20 years; and the ripples may yet be felt thousands of miles away. So what difference will it make to the rest of the world?

1. China’s devaluation may be best seen as a distress signal from Beijing – in which case the world’s second-largest economy may be far weaker than official figures suggests. If its economy really is much weaker, it would be alarming for any company hoping to export to China. China will remain a vast market; but it may not be quite such a one-way bet as some analysts have suggested.

2. China has been trying to shift from being a vast factory producing cut-price consumer goods for the rest of the world. With Chinese wages rising, making its products less competitive China’s Asian rivals, such as Indonesia and South Korea, will compete even harder in response; and the result may be a reduction in price of Chinese-made goods.

3. China’s demand for natural resources has been supporting the price of oil in recent years. So fears that China’s economy is in trouble tend to undermine oil prices – and that probably means cheaper petrol. In coming months, weak Chinese demand could force down the cost of many commodities, from oil to iron ore.

4. Central bankers in the US and the UK have been issuing warnings for months that, with growth strengthening, they are preparing to start pushing up interest rates, however, if the cheaper yuan cuts the price of imports, this will undermine inflation, which is already low; 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.

5. In the short term, lower-than-expected borrowing costs will benefit indebted consumers in the west. But some believe China’s decision is evidence of a lack of demand in the global economy, which will unleash deflation and undermine consumer spending. 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 on the floor.

6. Australia has experienced an impressive economic 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. So weakness in the Chinese economy is bad news for Australia.

7. If the Chinese devaluation does bring deflation to the global economy, the most vulnerable countries will 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). Greece, for example, is already suffering deflation after repeated cuts in wages and benefits as the government tries to balance the books, and if it worsens, that will only make its huge debts even harder to service.

8. Beijing’s move was offered as part of measures to open up its financial system, and allow foreign exchange markets more say over the value of the yuan. However, if Beijing allows the yuan to decline further it could cause a currency war, in which the world’s big trading blocs face off.

For now, a 4% 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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