The Chinese leadership’s devaluation of the yuan delivered a temporary shock to financial markets, but its longer-term effects may be felt around the globe
After China unexpectedly devalued its currency last week, one City economist shrugged despairingly and said: “It’s August.” While it’s 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 that presaged what later became profound shifts in the tectonic plates of the global economy — from the Russian debt default in 1998, to what Northern Rock boss Adam Applegarth called “the day the world changed,” when the first ripples of the credit crunch were felt in 2007; to August 2011, when ratings agency Standard and Poor’s sent shockwaves through financial markets by stripping America of its triple-AAA credit rating.
Taking the long view, last week’s devaluation by China, which left the yuan about 3% weaker against the dollar, was relatively modest — sterling had lost 16% of its value in 1967 when Harold Wilson sought to reassure the British public about the “pound in your pocket”.
But China’s decision 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. It could be serious
China’s devaluation may be best seen as a distress signal from Beijing policymakers – in which case the world’s second-largest economy may be far weaker than the 7% a year growth that official figures suggests. China has been trying to engineer a shift from export-led growth to an expansion based on consumer spending – while simultaneously trying to deflate a property bubble. Last week’s move, which loosened the yuan’s link to the value of the dollar, suggested some policymakers may 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 premier Xi Jinping, warned 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 the stodgy European economies. China was the sixth-largest destination for British exports last year.China will remain a vast market; but it may not be quite such a one-way bet as some analysts have suggested. And when it comes to the challenges facing Chinese policymakers, Russell Jones, of consultancy Llewellyn Consulting says: “The potential for getting this wrong is quite high.”
2. A less costly Christmas
China has been trying to shift from being a vast factory producing cut-price consumer goods for the rest of the world. Yet glance at the label on almost any T-shirt or toy – let alone consumer gadget – and it’s still likely to read “Made in China”. A country’s currency is not the only determinant of how much its goods will 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 will force China’s Asian rivals, such as Indonesia and South Korea, to compete even harder in response; and the result may be a few pence off the price of Chinese-made Christmas presents. Martin Beck, of consultancy Oxford Economics, says, “Almost 9% of the UK’s goods imports come from China, a share that has doubled over the last decade.” So there will be a direct disinflationary effect from cheaper imports.
3. Cheaper petrol at the pump
China’s apparently insatiable demand for natural resources has been a key factors 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 Britain. 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 below $50 a barrel. In coming months, weak Chinese demand could force down the cost of many commodities, from oil to iron ore.
4. Delayed rate rises
5. Deflation, deflation, deflation
In the short term, lower-than-expected borrowing costs will benefit indebted consumers in the west – including Britain’s mortgage-holders. But some analysts believe China’s decision is the latest evidence of a deep-seated lack of demand in the global economy, which will 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. And 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. Economist Ann Pettifor, of thinktank Prime, who foreshadowed the credit crunch in her 2006 book, The Coming First World Debt Crisis, believes the 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 borrowing. “It’s the pressure of debt on consumers, corporates, municipalities,” Pettifor says, raising the spectre of the kind of debt trap identified by the US economist Irving Fisher in the wake of the Great Depression. Not everyone is so pessimistic, and Carney has shrugged off the idea that deflation is a threat in the UK; but as Neil Mellor, of BNY Mellon, put it 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 by shifting the inflation dynamic at a most inopportune time.”
6. Tough times for Oz
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 neighbours, and China accounts for more than a quarter of its exports. So weakness in the Chinese economy is bad news for Australia. Research by consultancy Oxford Economics last week, which modelled the impact of a 10% Chinese devaluation, accompanied by a sharp slowdown, suggested other hard-hit countries could include Brazil, Russia, Chile and Korea.
7. Even more pain for Greece
If the Chinese devaluation does bring what one City analyst, Albert Edwards, last week called a “tidal wave of 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). And 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 will only make its gargantuan debts – worth more than 170% of the size of the economy – harder to service.
8. Currency wars
If Beijing allows the yuan to decline further in coming months, it could increase trade tensions, or even a “currency war”, in which the world’s big trading blocs face off in a beggar-thy-neighbour battle to seize the largest possible share of global consumer demand. 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.
“This news was published on The Guardian”