China is gradually allowing market forces to impact currency rates while grappling with its slowing economy.
This means the U.S. dollar appreciates, or rises in value, which hurts prospects for U.S. exporters because their products become more expensive abroad, says Fuqua School of Business professor Campbell Harvey. “If this devaluation persists and becomes more substantial, it could impact the Fed’s anticipated September rate hike,” says Harvey, who specializes in financial markets and global risk management. “This hike will make the U.S. dollar even more attractive to investors and lead to further dollar appreciation with our trading partners. This makes our exports less competitive and hurts U.S. economic growth.” He added: “A hard landing in China, no growth in the Eurozone, Japan in a 20-year stasis, and trouble in emerging markets like Brazil does not bode well for future U.S. growth -- devaluation or no devaluation of the yuan.”
Harvey says a relatively minor depreciation, 4 percent, is unlikely to have much impact on growth. It is China’s largest devaluation since 1994, but small compared to 1994 when the currency depreciated by one third, he says.
“Many of the Chinese government statistics are of dubious value. The GDP growth numbers are widely discounted. We do know that exports have fallen and inventories have risen,” he says. “These are bad omens for future growth and, in part, provide the mercantilist motivation for the devaluation.”
Harvey says one of China’s longer-term goals to become a reserve currency. China, the world’s second-largest economy, wants to be included in the IMF’s Special Drawing Rights (SDR) basket. To do that, Harvey says, China needs to show that its currency is driven mainly by market forces rather than government controls.
“To me, they are far from achieving that goal. Even with this devaluation, the float is perceived as very dirty,” Harvey says.
“The timing of the devaluation is no surprise. We have the backdrop of slower growth and the stock market bubble being pricked. In addition, it’s best to get this over in the dog days of summer -- before President Xi Jinping’s trip to Washington in September.”