Now on Sale! China’s Yuan

SMITH BRAIN TRUST -- Think of China like Walmart and the country’s recent currency devaluation like a price-slashing sale. “Devaluing your currency is a classic way to undercut competitors on price,” says Kristen Fanarakis, assistant director at the Center for Financial Policy at the University of Maryland’s Robert H. Smith School of Business. “When you put your currency ‘on sale,’ the products you export become cheaper for other countries to buy. It’s a way to encourage other countries to buy more Chinese goods.”

Unlike the U.S. dollar, the euro, and other free-floating currencies, the market forces of supply and demand don’t determine the value of China’s yuan. Instead it is set by the People’s Bank of China. But last week, the bank unexpectedly allowed the value of yuan to slide more than 4.4 percent against the dollar. This change to the way it determines the currency’s value toward a “managed float” regime from a fixed regime might suggest the PBOC wants to continue to weaken the currency in an effort to get the country’s lagging economy churning again. 

The  strength of the currency in recent years is one factor driving up the cost of manufacturing in China and the price of Chinese goods. With economic growth slowing, the Chinese government is looking for other ways to stimulate the economy. 

“When you start fiddling around in the currency markets, it can be an indication to the market that you haven’t been able to control things using other measures,” Fanarakis says.

Globally, the impact of China’s currency devaluation depends on how far it slides. The biggest underlying concern is the sheer size of the Chinese economy and the perception that the government is running out of options to stimulate the economy, Fanarakis says. China is the leader of emerging markets. So if China’s economy is doing poorly, that could create risk aversion to investing in all emerging markets and increase volatility across financial markets.

There could be big implications for other emerging Asian export-based economies, such as Indonesia and Vietnam that have enjoyed boosts in their manufacturing sectors as China’s has become more expensive. A cheaper yuan makes Chinese manufactured goods cheaper, which can take away the comparative advantage these other countries gained in recent years. The move also could spur other emerging Asian economies to devalue their currencies.

If the devaluation continues or volatility increases dramatically, the result could also halt a manufacturing uptick in the United States. In recent years, high oil prices and increasing labor costs in China led to some re-shoring of U.S. manufacturing. 

“If this became a trend, every U.S. manufacturer will be worried,” Fanarakis says.  

For now, consumers could see decreased prices on goods made in China. How the devaluation plays out for China’s economy is, in part, contingent on the U.S. and global economy and if consumers keep buying.

“If China doesn’t have buyers to export to, they can’t continue to employ people,” Fanarakis says. “The government wants continued economic growth and stability. There is nothing to preclude them from continuing to devalue their currency in order to get there.”

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