Chinese Yuan Devaluation: Will Things Change for the Better?

Recently, the Federal Reserve Bank of San Francisco commented on China's macroeconomic slowdown, albeit with some optimism towards the end. Shortly after the release of the Fed's report does China decide to devalue its currency: the yuan (¥). The devaluation, which was nearly at 4 percent, was the biggest devaluation in the past twenty years. The analysts over at Goldman Sachs believe that China is devaluing its currency in attempts to jumpstart its economy with a de facto stimulus because it makes Chinese exports cheaper while imports to China become more expensive.

What is interesting about this particular round of devaluation is that China is also allowing for more market forces in the currency market, not less. For one, China announced that it will set its daily reference rate to "the closing rate of the inter-bank foreign exchange market on the previous day," which is significant because it's no longer at the sole discretion of the central bank. China presumedly does this in the hopes that the IMF will add the yuan to its basket of reserve currencies.

Before continuing with my second point, let's consider previous accusations of China being a currency manipulator. I wrote on China's status as a currency manipulator late last year, and I came to three main takeaways: 1) any country with a central bank manipulates currency on some level, 2) China cannot keep up with its currency manipulation, and 3) it doesn't have the impact on America that naysayers think it does. Oh, and let's not forget that in spite of the manipulation, at least China is helping out the American consumer by making Chinese exports cheaper.

That being said, what makes this devaluation different is that China relaxed its monetary policy and allowed for market forces to devalue the yuan, which is different from previous intervention from China's central bank (中国人民银行). This lack of government interventionism, at least in this case, should change the tone for certain individuals running for presidential office launching accusations of "currency manipulator," although it very well might prevent the United States' Federal Reserve Bank from raising its interest rates (Keep in mind that back in May, the IMF stated that the yuan is not undervalued).

For me, it is more disturbing why China took the route of devaluation. On the whole, the yuan had been appreciating in the past five years, so let's remember what preceded China's announcement earlier this week. I think this was realized on the stock market because one did not see the volatility that would have been expected if this fact were forgotten. However, with issues in the euro zone and a lackluster recovery in the United States, demand for China's exports isn't what it used to be. It is not because of Chinese monetary interventionism in this instance (although Southeast Asia and the Euro zone will probably take a hit), but because of the slack in the global economy.

China allowing for some market forces to lead is a step in the right direction. We'll see if China sticks to its commitment to allow for currency market liberalization or reverts back to putting a leash back on its monetary policy as soon as it is inconvenient for China. In either case, China still has a while to go before its currency becomes internationalized. Until China liberalizes its economy, I'm afraid we'll see China continue to ride on a monetary roller coaster.