The world’s second-biggest economy shocked markets this week by depreciating its currency by the most in two decades, with the goal of aligning the yuan more closely to the market rate. China’s decision to make its goods cheaper for the rest of the world to buy also makes it more difficult for wages and consumer prices to increase globally.
The central bank’s decision to devalue the currency on Tuesday took markets by surprise, sparking a selloff in global equities and emerging market currencies. Further weakness could exacerbate capital outflows, make $3 trillion of dollar-denominated debt more expensive for Chinese borrowers and put pressure on export rivals to devalue their own currencies.
The PBOC made the shift after months of stability against a strengthening U.S. dollar had seen China lose competitiveness against other Asian nations, weighing on exports. Currency reserves have slumped $315 billion in the year to July to $3.65 trillion as the central bank kept the exchange rate stable.
The record devaluation of the yuan has dragged down almost every currency in Asia. As they drop, the foreign debt bills of the region’s companies are rising. Almost $1.6 trillion of bonds and loans denominated in dollars and euros across Asia outside Japan and China has just become $14 billion more expensive for companies that service the debt in their home currency.
It could have also an impact on the FED decision to increase rate expecting in September. Indeed, if more devaluation has to come, it could send waves of deflation to the west to overwhelm already struggling corporate profitability and take the world back into outright recession. Inflation expectations for the U.S. tumbled this week to the lowest since January. The gap between yields on U.S. five-year notes and similar-dated Treasury Inflation Protected Securities shrank to show traders expect annual consumer-price growth to average 1.27% through 2020.
This is a big shift for Chinese authorities. They are usually slow to react but the move is unlikely to be a short one. The FED does not give anymore the tempo of the world monetary policy.