In a recent conversation with Tyler Cowen, the question was raised as to why China doesn’t combat deflation by devaluing the yuan. One possible explanation could be the pressure exerted by the US. A recent Bloomberg article sheds light on this issue:
- The People’s Bank of China (PBOC) has been resisting a devaluation of the yuan since the US election in November. They have kept the yuan’s drop around 7.3 per dollar by controlling the daily reference rate. This restriction limits the movement of the onshore yuan within a 2% range on both sides since late January. Additionally, they have refrained from interest-rate cuts and bond purchases this year, allowing a funding squeeze among banks to prevent further depreciation and capital outflows.
- Ken Cheung, chief Asia FX strategist at Mizuho Bank in Hong Kong, noted, “Despite the upcoming extra 10% tariff hike, the PBOC will probably refrain from tweaking its steady yuan fixing policy, considering Trump’s warning on yuan depreciation.” The PBOC appears to prioritize currency stability during the National People’s Congress.
Parallels can be drawn to the US government’s actions towards Japan in the 1990s and 2000s, which inadvertently led to deflation. It is concerning how policymakers can unknowingly harm economies due to a lack of economic understanding. In the long term, deflation in China may eventually restore equilibrium, with the real exchange rate depreciating while the nominal rate remains fixed. However, the famous quote from Keynes reminds us of the inherent uncertainty in predicting the future.
China doesn’t necessarily need a weaker yuan in real terms, but a nominal devaluation could significantly boost its Nominal Gross Domestic Product (NGDP) growth rate. Surprisingly, monetary stimulus may not result in an increased current account surplus, as accelerated economic growth could lead to a surge in imports, offsetting any potential export gains from a weaker yuan. The income effect might outweigh the substitution effect in this scenario.
In conclusion, the complexities of international economics underscore the importance of policymakers understanding the implications of their decisions. China’s situation with the yuan exemplifies how various factors interact in a delicate balance that can have far-reaching consequences. It is crucial for policymakers to have a holistic comprehension of economic principles to prevent unintended negative outcomes.
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