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Renminbi IW News 12. August 2015

No currency war on the horizon

The Chinese economy has been running out of steam. Now, the central bank decided to depreciate the Renminbi and many financial actors fear this step as if a currency war will begin. However, the depreciation is just a logical step in the context of the current economic development and the recent strength of the dollar.

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The Chinese currency has been devaluating – thanks to the interventions of the Chinese central bank in the foreign exchange markets. As a reaction, the financial markets have been getting nervous fearing the onset of a currency war. However, precise analysis of the recent Renminbi development shows that this fears are largely unfounded: The Chinese currency would have depreciated against the dollar long ago in the hypothetical situation of a flexible exchange rate regime – as it was the case with the currencies of other emerging economies and the Euro.

Pegging the Chinese Renminbi to the dollar was a good strategy in times of weakness of the US currency – this boosted export revenues, at least in the short run. However, the recent appreciation of the dollar has called the adequacy of this policy into question, since pegging the Chinese currency to the dollar also means importing its course of appreciation. The Renminbi value was forced to gain 15 percent in value against the euro within one year. Moreover, Chinese goods have been getting more expensive not only for Europeans; the Chinese currency, pegged to the dollar, has appreciated against a wide range of currencies across the world.

The recent strength of the dollar is not surprising given the increasing stability of the US economy and the macroeconomic dynamics. The growth of the Chinese economy, on the contrary, has been downwards sloped and the financial markets have been trembling. Therefore, the macroeconomic fundamentals are pointing to devaluation. The intervention of the Chinese central bank is a logical reaction to the recent economic development in the Middle Kingdom and not necessarily a sign of a beginning currency war.

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