China's unexpected 2 percent single-day devaluation of the yuan on Aug. 11 shocked the world. What are the implications of this biggest fall since 1994?
Behind the 2 percent drop is a new exchange rate mechanism that's supposed to better reflect market forces, according to China's central bank. The yuan is now at its weakest against the dollar in almost three years. Some analysts foresee the slide to continue in the longer term.
The move is apparently designed to inject vitality into China's slowing export sector and the overall dragging economy.
History moves in a spiral. Almost exactly 10 years ago, in this July 25, 2005 report, I wrote about China's announcement of strengthening of its currency by 2.1 percent and its claim to take the yuan off its peg to the dollar for a more market-based system. At the time, the U.S. plastics industry welcomed the move, and hoped it would help reduce the U.S. trade deficit with China and bring manufacturing jobs back to the U.S.
What happened in the following decade is summed up in these two graphs. At the top is one from xe.com, showing the yuan/dollar rate. And I made the second one with U.S.-China trade deficit data from the Census Bureau.
Today's China is in a drastically different position compared to 10 years ago. It has lost cost advantages to many other developing countries. The export sector has been cooling off, while the domestic market has yet proven to be able to sustain high growth.
In the plastics industry, in particular, China saw its export of processed plastics products increase by a whopping 2.3 percent based on dollar value in the first seven months.
A cheaper yuan will no doubt increase the price competitiveness of Chinese products in the export market. It will also give domestic manufacturers an edge in the domestic market against imports — think about the cut-throat plastics machinery market, for instance.
On the flip side, the devaluation will also hurt Chinese companies that reply on imports (assuming there is no convenient domestic alternatives) as well as companies with dollar-denominated credit.
If China's plastics industry indeed runs an $8.4 billion trade deficit as I recently wrote in my blog, it'd be interesting to see how a depreciating yuan will affect that trade balance. China still imports a significant amount of plastics resins as well as high-end machinery and molds.
For the U.S. plastics industry, I don't really see a major impact on investment, jobs, or foreign trade in the immediate term. The ongoing shift of manufacturing from China to other parts of the world including reshoring will likely to continue as well. That's unless China decides to play with the currency with more drastic moves. It might. China has never failed to throw surprises.
Let's not forget China has in the past year or so pretty much pegged its currency to the U.S. dollar, during which time it, along with the ever-strengthening dollar, appreciated significantly against other major currencies like the euro and Japanese yen. As a result, Chinese exporters have faced headwinds in those markets, and European and Japanese machinery makers enjoyed tailwinds in the Chinese market. Significant currency depreciation against the dollar has also been seen in Southeast Asia, which has been winning manufacturing orders and investments away from China.
Republican presidential candidate Donald Trump today labeled China devaluation of the yuan as “devastating” for the U.S. But he also said “We have so much power over China” in a CNN interview. But it's not just about the U.S. and China, is it? The world is so interconnected today that China's pains and gains could have more far-reaching ramifications than one might think.
We are living in some turbulent times.