2

China’s Daring Depreciation

BEIJING – On August 11, the People’s Bank of China (PBOC) lowered the central parity rate of the renminbi by 1.9%, sending shockwaves around the globe. Many foreign commentators condemned the devaluation as a blatant attempt to boost Chinese exports – a move that would, they warned, spark a new round of currency wars. But there are good reasons to believe that this was not China’s motivation at all.

In fact, China knows full well that currency wars are self-defeating. During the 1997 Asian financial crisis, China’s economic situation was much worse than it is today, but the government still resisted the temptation to devalue the renminbi – and the country managed to emerge from the crisis virtually unscathed.

Today, a devaluation would probably do little for China’s trade surplus. After all, the country already accounts for more than 12% of global exports, so expanding its share further would probably worsen its terms of trade. The dominance of processing trade in China – the import of raw materials and components and the export of finished goods – makes the effectiveness of devaluation even more dubious.

Moreover, China now holds a massive volume of overseas assets and liabilities; its non-financial corporations have borrowed as much as $1 trillion abroad. As devaluation causes businesses’ debt burdens to grow in renminbi terms, the risk of non-performing loans and bankruptcies rises.