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This article discusses the recent devaluation of the Yuan by the People’s Bank of China (PBOC). The reason behind this could be twofold: either to move the Yuan towards the market rate, thus moving the economy towards reform, or to make exports more competitive, thus helping China’s poor growth recover. Both are equally plausible: China is facing a more pressing need to shift its economy from an export-led one to a domestic demand one. Moving the Yuan towards the market rate helps shift the economy. However, as China has been facing increasingly disappointing export rates, the devaluation may help pick it up. Future moves by the PBOC will tell which one China is more concerned with. Such moves may include how China reacts to a market rate appreciation or how it reacts to future problems that could be solved by currency manipulation.
This move causes major political repercussions. The Fed’s interest rate hike is likely to happen in September, but this devaluation may postpone this increase. Therefore, the subject is bound to occupy many presidential debates. Furthermore, China’s leadership has been hoping to become an official reserve currency, which is less likely at the face of the devaluation.
1. It is important to understand, firstly, how devaluation could help the export sector of the economy. A currency that has been recently devalued causes the prices of all domestic goods and services to be relatively cheaper in foreign countries, thus encouraging foreign countries to purchase more domestic goods and services, i.e. the domestic economy is now exporting more.
2. In the second paragraph, the article cites “many other efforts to boost the economy”. These efforts are mainly:
1. Cutting interest rates 5 times in the last 12 months. The interest rate is currently 4.6%. Note that this is expansionary monetary policy.
2. Cutting the bank reserve ratios. Reserve ratios are a legally mandated percentage of all deposits that must be held with the Central Bank. In other words, if I were to deposit some money into a local bank, a certain percentage of that deposit must be held with the Central Bank, while the rest can be given out as loans by the local bank. In China, this percentage is 18%. Reducing the reserve ratio means that more money can be lent out by the local bank, thus encouraging spending and boosting up GDP and growth.
3. This article also mentions China’s wish to be an “official reserve currency”. All countries hold reserve currencies in the form of GBP, USD, Yen, Euro and SDRs. SDRs, Special Drawing Rights, are a concept created by the IMF, and act as a currency that can be used in foreign markets. The IMF explains it here. China wishes to be an official reserve currency.
4. The Treasury Department, U.S. Congress and some American businesses all claim that the Yuan is artificially low – that it should be higher. It is important to understand that this has no economic backing, but is used as a political tool to gain support. According to the IMF and international markets, the Yuan is moving closer to the market rate by being devalued.
5. According to this article, China’s cabinet has been “[offering] tax breaks and other incentives to help the trade sector.” These tax breaks and other incentives fall under the umbrella of fiscal policy.