Once again China has commanded the headlines, this time over the miss-characterized “devaluing” of the yuan renminbi (RMB), the Chinese currency. The currency wasn’t so much directly devalued as it was allowed to more widely de-peg from the US dollar and let market forces play a more direct role in the valuation of the currency. This lead to a weaker currency.
Though somewhat opaque, the People’s Bank of China allowed a 2% daily trading range on the value of the renminbi, widely understood to have a de facto peg to the USD. On August 11th, the PBoC changed that to allow a wider range based on the previous day’s closing price. This placed the currency’s value more directly in the hands of the market in a managed float, rather than a USD-peg. That the currency dropped in value shows that it was artificially high due to its USD peg, which has had a measurable negative impact on their exports. The move makes it more likely that the RMB will be included in the basket of currencies comprising the International Monetary Fund’s (IMF) Special Drawing Rights (SDR), a stated goal. This currently includes the euro, yen, US dollar and British pound sterling.
To us, this shows China to be serious about liberalizing their capital account, and to be able to be considered for the SDR. This requires that it be a “freely usable currency.” According to the IMF: “The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies, and SDRs can be exchanged for freely usable currencies.”
There are several reasons why this makes sense and should help China in the long run, despite initial volatility. First, China owns a huge amount of US debt, in Treasuries. An expected rate hike in September (or any later hike) would have a tremendous negative impact on these Treasuries’ value, while simultaneously raising the value of the renminbi against the value of China’s economic competitors. A devalued currency would make up for some of that; already, in the first six months of 2015, the PBoC managed the largest sale of reserves in the last two decades.