Pettis: China Won't Devalue

WSJ: Why China Won’t Devalue the Yuan
The arguments in favor of devaluation are straightforward. China’s economy is slowing sharply, in part because of declining exports. After many years of current- and capital-account surpluses, the past two years have seen a large balance-of-payments deficit, and China’s central bank had to intervene heavily to support the yuan.

Developing economies usually respond in such situations by devaluing their currencies. Supporters of devaluation claim that China should do the same to regain export competitiveness and reverse capital outflows.

This comparison is mistaken. China is the world’s second-largest economy and runs the second-largest trade surplus in history. Developing economies that devalued successfully were much smaller, which made it easier for the world to absorb their export surge. They also devalued only after their overvalued currencies had caused persistently large deficits.

In contrast, the yuan is not overvalued. In fact it is undervalued, as Governor Zhou all but acknowledged in an interview with China’s financial magazine Caixin three months ago.
China already inflated the yuan. Rapid growth in money and credit created the potential for a large devaluation. China doesn't have excess savings, it has excess credit and money sloshing around the economy setting off a bubble every six months.

If the yuan is undervalued, then we'll know for sure if the U.S. dollar breaks 100 on the way to 110 and USDCNY is still only 6.5 or 6.6, and Chinese imports soar as exports slow. Then we'll know China has healthy domestic growth and an undervalued currency. I suspect China isn't so healthy and if the dollar rebounds, the yuan will eventually reach the red line of USDCNY 6.8, the level at which it was pegged from 2008 to 2010, before beginning a rapid descent.

In the rest of the article, Pettis explains why currency devaluation won't help China export and how it will create friction with trade partners, all of which is true. I don't think China wants to devalue, rather I believe the potential is there. If conditions turn out favorably (global economic growth increases, U.S. dollar declines being two key ones) there need not be devaluation, but I expect conditions will not be favorable.

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