Scott Sumner  

Was China's devaluation a beggar-thy-neighbor policy?

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I've argued that devaluations are not beggar-thy-neighbor policies. More specifically, the Chinese need to devalue their currency to boost NGDP (and RGDP) growth, and that this would also help the world economy, as a more prosperous China would import more goods.

And yet, news reports this morning suggest that China's 2% devaluation last night boosted Chinese stocks and hurt western stocks. Was I wrong?

It's possible I am wrong, at least in this case. (There are lots of other cases where monetary easing in one country boosted stocks all over the world.) But there are lots of puzzles here that I am having trouble figuring out:

1. Yesterday I did a post discussing the Chinese government's announcement that they would let the yuan fluctuate more. This announcement was seen as expansionary, and Chinese stocks soared 5%. US stocks also did well, although I have no idea whether this was related to China.

2. Despite the press reports that Chinese stocks rose on news of the devaluation, the Shanghai market was actually down slightly today, and was pretty flat all day. So I don't see much response, compared to the huge response yesterday when the new currency policy was announced.

3. Australia is one country that might be helped by a beggar-thy neighbor policy in China. It doesn't produce the stuff China does, and it sells lots of commodities to China, which should benefit from a faster growing Chinese economy. But its markets were down yesterday. Why?

4. Here's one report that hints that the modest 1.86% devaluation was a disappointment, relative to the previous news that a devaluation was coming:

"Over the last two years, since the Taper Tantrum summer, the yuan has dropped 3 percent against the dollar, but the yen's fallen 23 percent, the Euro 18 percent, and other Asian currencies have fallen by between 5 percent and 25 percent," said Kit Juckes, global head of foreign exchange strategy at Societe Generale.

"Relative to those moves, the Chinese adjustment is a token move that won't do anything to stop the economic slowdown. Whether or not the PBoC intends this to be the start of a series of steps towards a more competitive currency, the domino effect to weaker commodity prices and weaker currencies across EM and resource exporters will be hard to stop," he added.

So perhaps it's one of those too little too late, and not up to expectations situations. Nonetheless, I don't find this explanation very satisfactory either. It would be useful to have inter-day data from Shanghai on the exact move in Chinese stock prices on the announcement. Right now I'm confused (although gratified that the Chinese did devalue a bit, something I recommended a few weeks ago.)

One other thing that would help is if the Fed actually tried to hit its 2% PCE inflation target, by cutting the interest rate on bank reserves. I predict that a "beggar-thy-neighbor" easy money policy in the US would boost foreign stock prices, even if the dollar fell in forex markets.

PS. Remember that exchange rates don't affect trade balances in the long run, which are determined by China's saving policies. Given their demographics, China should probably be saving even more, and may well run even larger surpluses in the future.

HT: TravisV

Update: Commenter dlr provided the following information:

Scott, the intra-day charts do not help much. The announcement came at about 9:30pm est when the Shanghai Comp opened, and it bounced mildly around a flat line for the first couple hours of trading. The Hang Seng initially jumped ~1.5% on the announcement and declined through the session to close flat. S&P futures declined about 70 bps in the hour following the announcement, with about a 30 minute reaction delay.

COMMENTS (14 to date)
dlr writes:

Scott, the intra-day charts do not help much. The announcement came at about 9:30pm est when the Shanghai Comp opened, and it bounced mildly around a flat line for the first couple hours of trading. The Hang Seng initially jumped ~1.5% on the announcement and declined through the session to close flat. S&P futures declined about 70 bps in the hour following the announcement, with about a 30 minute reaction delay.

mike davis writes:

Re: Scot's PS: Is it more important and/or likely that the Chinese will increase the rate of saving or increase the efficiency of investment? I have the impression that the Chinese who are in a position to save—those who have moved out of the grinding poverty of the rural areas—are well aware of the need to save. They know there’s not a public safety net and they know that there isn’t a big family network with lots of siblings to support elderly parents. Could it be that the bigger problem is that all the sludge in the financial system is leading to a pattern of inefficient investment? Whether the core deficiency is bad governance or just Chinese inexperience with finance is something we need to think about. But without the mechanisms to efficiently transform saving into the new capital that will produce the stuff that the aging population needs, it’s going to be tough.

Scott Sumner writes:

Thanks dlr, That confirms my suspicion that the press reports were a bit sloppy. My hunch is that Monday's market showed the actual response, and that the 1.86% devaluation was a bit disappointing, hence not much further reaction.

Mike, Yes, there's plenty of wasteful investment, but don't underestimate how much good investment there is as well. The Chinese are building a first rate system of infrastructure at surprisingly low cost. Housing is a different story.

I would expect investment as a share of GDP to gradually decline over time, which is why I think the CA surplus might get even bigger. (Of course saving could change as well but I agree with you point about the safety net.) Also, don't underestimate how much the poor in China save, it's a lot more than you'd think.

Anon writes:

(Somewhat) related question:

When the Swiss unpegged the Franc, did the currency move when the event was announced or when the SNB literally stopped the manipulation?

Can anyone with any understanding of how exactly the forces move in this kind of event, provide an explanation?

Been bugging me for a while.

I mean, I'm pretty sure the answer is "on announcement", but what would have happened if they just slowly reversed policy without announcing it outright?

I'm also assuming the actual policy reversal began happening before the announcement (or else the SNB would have taken large losses), so why was there virtually no movement prior to the announcement?

Someone help me understand, please!

Rajat writes:

Scott, I was about to say that intriguingly, the ASX rose first thing on Tuesday (the PBOC move happened overnight our time) and only starting falling a while later. But then today another devaluation and another decent drop in the ASX. It's being reported in our financial press as "Clear intent to weaken RMB. Not good for global growth and many markets". That's from a major bank strategist.

Rajat writes:

The same market strategist has now elaborated by saying, "there is concern in the financial markets that China's RMB move signals a weaker economy than previously thought".

Rob writes:

Hi Scott

The markets are down in Australia (latest move is that the market experienced the biggest fall since 2012) largely due to the over investment concerns in Australian minerals and Chinese housing (consuming c.40% of Chinese steel).

You have the official Chinese steel association putting out projections for Chinese steel consumption that are lower than BHP and RIO's projections for China (i.e. the Australians are in denial regarding the iron ore forward curve).

We Australians are scrambling to come up with a narrative on where growth is going to come from to support our mineral exports and are trying to pump the Indian urbanisation story. Alas, the Orica CEO (largest blasting/explosives company in the world) came out yesterday and rejected those projections too. So we have overbuilt our mineral producing capacity and the projected returns are not going to justify the equity investment and many large firms (Fortescue) are at risk of insolvency come 2019 when many of their bonds are due to be rolled over. Our terms of trade shock (c.70% deterioration since the peak in 2013) is just starting to be felt.

We also have our big 4 banks reporting this week and the sentiment is that bad debt charges have hit the bottom and that their trading conditions have peaked. They are being pressured by regulators to increase their capital to 10%. So that is also impacting the ASX 200 index - they have the largest weighting on an index when compared to other developed countries. UBS thinks it is the largest weighting in the history of stock markets. Good times.


Johannes Fritz writes:


the SNB statistics don't tell us when they intervene exactly. They only produce weekly averages of bank sight deposits which tend to correspond to increases in SNB foreign holdings at the moment, but don't need to in general.

My hunch is that they removed their open positions at the time of the announcement. Anything else would have threatened the secrecy of the operation. I doubt that many people outside the SNB board knew what was going to happen even hours before the event.

I think your assumption that the SNB stopped intervening before the announcement is probably incorrect for that reason, but also because we see sight deposits move around the event.

For one, the bank sight deposits increased substantially in the week of the float (329 bn -> 348 bn). Here we don't know what portion was increased before the float (a Thursday). Still, the SNB said that they decided to float observing ever increasing needs to intervene.

For two, the SNB likely intervened heavily in the week after the float (around 30bn).

As I said, unfortunately it is impossible to decipher when they intervene exactly. They execute these orders through different commercial banks to remain unidentified.

Johannes Fritz writes:

Dear Scott,

about your PS: Does the S-I=NX not refute such beggar-thy-neighbour allegations on an even more basic level?

Easing monetary conditions should decrease saving while lifting investment. Thus NX should fall.

Scott Sumner writes:

Anon, Markets move on the announcement, otherwise there'd be unexploited profit opportunities. The SNB had no way to avoid losses, whether they announced it or not. The only way to avoid losses would have been to not devalue, which would have been the wiser move.

Rajat, Your second interpretation is the only one that makes sense. Obviously a Chinese devaluation would not in and of itself slow global growth, just the opposite. Markets seem to think the Chinese government knows something that they don't.

It's also weird that the Chinese stock market soared Monday on the announcement that they would liberalize, and then fell today on the actual devaluation. Very strange.

Rob, Thanks for that info. It's amazing that anyone made investments based on the assumption that the Chinese commodity boom would last for ever. It's normal for countries to switch from commodity intensive to service intense growth as they get richer.

Johannes, It's dangerous to make any causal argument based on an identity. I agree that monetary stimulus often reduces NX, but I don't believe that's always true.

Anon writes:


My hunch was that it moved on announcement, but that raises some other questions for me:

  • Was the actual cessation of intervention timed exactly with the announcement?
  • Johannes Fritz (in his comment above) implies the SNB kept intervening somewhat even *after* they announced (e.g. slowly backing off). What would be the point of that? Wouldn't that just cause them huge losses? Why not just exit completely at once? (Too major of a shock maybe?)

The question that I'm most perplexed about:

Why wouldn't the SNB just gradually cease intervention over a period of months without ever explicitly announcing it? Why would that be more costly than a shock announcement? I think your implication is that investors would figure out and front-run the SNB - but how would investors know that the SNB was going with a completely free floating exchange rate vs. just lessening the devaluation slightly? Also, given the above, it seems like they were front-run anyway (as announcement came before full policy change), so what difference did it make exactly?

Does this all just go back to some vague "transparency" argument or am I missing something here?

Travis Allison writes:

Couldn't a beggar-thy-neighbor policy occur if the US Fed were perceived as being unwilling to ease policy unless things got dramatically worse? That is, the Fed isn't perceived as being close to more QE. So if China devalues and the dollar increases, then the demand shortfall produced by US purchasing Chinese goods won't be closed by the Fed.

Scott Sumner writes:

anon, They kept buying afterwards in order to prevent an even greater appreciation in the SF.

The losses occur due to the fall in the SF value of their foreign exchange holdings. That loss occurs regardless of whether they move before or after the announcement.

Travis. Maybe, but faster growth in China would help the US regardless of whether we responded or not. That's the "income effect." The net effect is unclear.

And I think it is very likely that the Fed would respond to anything that impact AD in the US.

Dan Carroll writes:

My impression was that stocks (and commodities) rallied on the Monday announcement, but reacted negatively that the devaluation was a modest 2%. Perversely, a modest devaluation could accelerate capital flight. It signals a willingness to devalue, while the modest amount suggests that there is more to come. It might be a "get out while you can" response by the Chinese. Note that the dollar is up 21%.

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