Forex Race to the Bottom

The recent Chinese currency devaluation is simply the most recent episode in the international Forex race to the bottom. To understand the wide spread monetary policy of currency devaluation, we should ask why did China devalue its currency? The New York Times offers its opinion.

Here are two things that China’s government wants very badly: first, for its economy to remain on an even keel, keeping growth and employment high. Second, for its currency, the renminbi, to become a pre-eminent global currency that helps promote the country’s diplomatic goals and solidify the country’s centrality to the global economy.

Frequently those goals are in conflict. But Tuesday, China did something it thinks will advance both at once.

That’s how to make sense of some blockbuster news out of Beijing that the country will adjust how it manages the renminbi to make the currency’s value respond a bit more closely to market forces.

It is all about economic stimulus and gaining and maintaining economic strength by making your exports cheaper and more competitive in the rest of the world. And the Chinese are not alone in doing this. And, remember that the IMF delayed its decision to declare the yuan an international reserve currency. China will need to get its currency and economic houses in order to achieve that goal.

The Currency Devaluation Race

The Australian simply notes that China is joining the currency devaluation race.

Many central banks around the world, including those in emerging markets, have been forcing down their currencies to boost their export industries.

China, until now, had been ­reluctant to join the “race to the bottom” game of competitive ­devaluation. Then it dropped an A-bomb on the market yesterday by allowing the Chinese yuan to drop as much as 1.9 per cent.

But while the move is dressed up as part of the currency reform program, the economic imperative is obvious. The yuan has appreciated between 20 and 30 per cent lately, one of the strongest performing currencies. This is against the backdrop of the sharp fall of the euro, yen and other emerging market currencies.

This is putting China’s export industry, one of the key engines of growth, under great pressure. Alicia Garcia Herrero from Natixis Asia Research said the extremely weak July export data published last weekend must have pushed the PBoC to use one of its most powerful instruments, the exchange rate, to reboot the Chinese economy.

The Euro Zone is also pushing its currency lower with a 1.1 trillion stimulus program. Like the Chinese devaluation and stimulus programs the Euro stimulus is mean to create jobs and to make European exports more competitive.

How Does This Affect U.S. Interest Rates?

The U.S. dollar stands out as the only major currency that is going up, especially with the prospect of higher interest rates this year. CNBC ask how the China devaluation may impact the Fed.

China’s surprise devaluation of its currency is an admission of economic weakness and could delay the timing of the Federal Reserve’s expected U.S. interest rate hike, strategist Boris Schlossberg told CNBC on Tuesday.

While agreeing the currency move signals economic troubles in China, Jim McCaughan, chief executive of Principal Global Investors, said the Fed will focus on the domestic economic data instead of trying to extrapolate how a slowdown in the Chinese economy might slow activity in the U.S.

If you agree with this line of reasoning you will expect a slightly delayed interest rate hike in the USA and continued strength of the dollar as other majors engage in a Forex race to the bottom.