Opportunistic Flexibility

Last week, China moved to allow more flexibility in its exchange rate.  In this case, that meant a downward movement - headlines about a "devaluation" were rather overstated, though, as the depreciation from Monday to Thursday was about 3% (followed by a slight rise on Friday).  Last week's change is at the end of the graph:

Note, the graph is the yuan price of a dollar, so a downward movement is a yuan appreciation.

China has been criticized over the years for keeping its exchange rate undervalued to support its exports.  The graph shows that it has allowed the yuan to rise quite a bit since 2005, though it has done so in a controlled manner and took a pause for about two years starting in mid-2008.  Its appreciation has helped China make progress on one aspect of "rebalancing" - reducing its dependence on exports.  China's current account surplus is considerably smaller relative to GDP than it was in 2006-08:

So, does this move represent a return to China's old ways of undervaluing its currency to gain a competitive edge for its exports?

Well, yes and no...

As it has followed the dollar, and the dollar has risen, the yuan has appreciated in real terms.  This chart shows a trade-weighted average of the dollar:

During the last year the dollar has appreciated significantly and the yuan has been along for the ride.  Currency appreciation - which makes Chinese goods relatively more expensive on world markets - combined with a slowing economy led to political pressure for a change of course.  The Times' Keith Bradsher writes:

In a little-noted advisory to government agencies, the cabinet said it was essential to fix the export problem, and the currency had to be part of the solution.

With the government keeping a tight grip on the value of the renminbi, Chinese goods were more expensive than rivals’ products overseas. The currencies of other emerging markets had fallen, and China’s exporters could not easily compete.

Soon after, the Communist Party leaders issued a statement also urging action on exports.

However, China has also been moving in the direction of greater financial openness; this entails allowing freer exchange rate movements (as I discussed in this previous post), particularly if it wants the yuan to become an international reserve currency (a status Krugman rightly notes is highly overrated).  At Project Syndicate, Yu Yongding writes:

From now on, China’s government declared, the renminbi’s central parity rate will align more closely with the previous day’s closing spot rates. This suggests that the devaluation was aimed primarily at giving the markets a greater role in determining the renminbi exchange rate, with the goal of enabling deeper currency reform.

So, yes, China has other reasons for moving to a more flexible exchange rate, but it is convenient for them to take a step in that direction at a moment when doing so means a fall in the yuan that will boost demand for Chinese goods.

See also: Ambrose-Evans Pritchard, Gavyn Davies, Michael Klein, David Beckworth, Michael Pettis.