China Destabilizes Global Economy by Exporting Deflation Through Currency Devaluation

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If Brexit and wobbly Italian banks weren’t enough to worry about, another major economic risk, that of deflation, is only getting worse. The Telegraph’s Ambrose Evans-Pritchard has warned for some time that if China were to devalue the renminbi, it would add considerably to already dangerous deflationary pressures.

It’s not surprising that China would reduce the value of the renminbi vin the wake of the Brexit vote as the pound has plunged and the euro has weakened. in 2013, the EU was China’s biggest export market but by 2015, it had fallen to its second largest market, which could make Chinese officials concerned about further erosion of their position. As Evans-Pritchard stresses, the Chinese are presumably using the furore over Brexit to execute this move when officials are distracted.

But the rationale for this measure is to shore up an unsustainable mercantilist growth model. As many analysts have stressed, China has for years has had investments and exports consist of an unheard of level of over 50% of GDP. China desperately needs instead to have a much larger consumption share of GDP. But in the wake of the criss, it instead ramped up investments that have been mainly funded by borrowing, with the boost in GDP from each dollar of borrowing falling over time. So the investment-driven model is nearing its sell-by date, yet the economic mandarins are doubling down.

And as Evans-Pritchard outlines, the result of this last-ditch effort to preserve Chinese growth will be to kill its export markets. Germany, the world’s other relentless exporter, is achieving a similar result by insisting on running trade surpluses, refusing to fund its counterparts (which is inherent to running trade surpluses) and insisting that the problem is that their partners aren’t competitive enough and inflicting crushing austerity and labor-squeezing policies on them.

Evans-Pritchard also highlights that China’s policies are fueling protectionist backlashes. And the reason the responses may wind up being extreme is that we failed to take more measured steps years ago. As William Greider has been pointing out for years, our form of globalization is one of managed trade, not “free” trade. The US has allowed our trading partners to structure arrangements that allowed them to protect their workers and run trade surpluses (or at least avoid trade deficits) at our expense. The US Treasury has also failed to deem China a currency manipulator in its semi-annual certifications even though there have been periods when the designation unquestionably fit. The big reason for sitting pat was geopolitical: China made clear that it would regard that move as provocative and the implication was that they would retaliate. But now with China taking an aggressive stance in the South China Sea, some confrontation a decade ago might have forced a realignment. Now the political and economic stakes are vastly higher, leaving virtually no room for error. And the default of letting China continue on its current path is certain to end badly.

From the Telegraph:

China has abandoned a solemn pledge to keep its exchange rate stable and is carrying out a systematic devaluation of the yuan, sending a powerful deflationary impulse through a global economy already caught in a 1930s trap….

Mr [Mark] Williams [of Capital Economics]said it is unclear whether Beijing intended to deceive investors all along when it gave categorical assurances earlier this year, or whether it is feeding on events….

Factory gate prices within China are falling at a rate of 2.9pc, further amplifying the deflationary impact. Analysts fear that Beijing is engaged is an undeclared policy of beggar-thy-neighbour mercantilism, trying to avert an industrial crisis at home by exporting its overcapacity in steel, shipbuilding, chemicals, plastics, paper, glass, and even solar panels, to the rest for the world.

“When you have a relatively closed capital account like China, it means that any currency move like this is a policy decision,” said Hans Redeker, currency chief at Morgan Stanley.

“They seem to be overriding their own model and letting the remnimbi (yuan) fall to improve competitiveness. They are in the same sort of deflationary syndrome as Japan in the 1990 but on a much bigger scale. The global economy is in no position to absorb this.”

Import prices in Japan have collapsed by 20pc over the last year, 5.5pc in Germany, and 5pc in the US, despite the recovery oil prices. Mr Redeker said China’s attempt to export its problems though devaluation is a key reason why inflation expectations are crashing to record lows across the developed world.

This in turn is driving bond yields to historic lows almost daily, with 10-year borrowing costs down to -0.58pc in Switzerland, -0.28pc in Japan, -0.16pc in Germany, 0.14pc in France, 0.78pc in Britain, and 1.4pc in the US…

The latest twist comes from the foreign reserves data, which suggest that China may have begun to intervene actively in the markets to drive down the yuan. This would have grave repercussions. Provisional figures imply that the PBOC purchased a net $34bn of foreign bonds in June, once valuation distortions are stripped out.

As we have also warned, ZIRP and negative interest rates are destructive to banks, life insurers, and pension funds. Both the real economy and financial assets suffer in deflation. Despite lofty-looking valuations now, a financial asset is someone else’s financial liability. Many of these claims will be marked down as businesses and households struggle under sustained low growth-recessionary conditions.

The economist Herbert Stein said, “If something cannot go on forever, it will stop.” However, China has made an art form of defying Stein’s saying. And every major economy that has moved from an export-driven model to a consumption-driven one has suffered a major crisis. There are thus good reasons to expect things to end badly, but when is anybody’s guess.

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  1. Charles 2

    China is different than Japan in that it can afford to go inward. A collapse of world commerce due to protectionism will lower the price of the only thing it is interested to buy abroad now, I.e. Commodities. A devaluation enhances the value of sovereign assets while leaving the values of liabilities intact. The currency gains can be used to plug the bad debts from the investment bubble. Sprinkle some helicopter money to keep masses quiet and the Party chugs along.

    1. Yves Smith Post author

      If this was all so easy, don’t you think the party officials would have moved in this direction already? Instead, China’s consumption as a percent of GDP has fallen since the crisis.

  2. jgordon

    An economic system based around exporting cheap crap that’ll end up in landfills in a few months was never sustainable in the first place.

    Just imagine if they’d mobilized their entire economy into more projects like the Loess Plateau rather than exporting garbage. Case in point of how fiscal and monetary stimulus can and will be far worse than doing nothing at all if the leadership and overall culture are operating under the wrong assumptions.

    1. cnchal

      Just imagine if they’d mobilized their entire economy into more projects like the Loess Plateau rather than exporting garbage. . .

      Had they done that, the Chinese leaders wouldn’t have been able to steal billions and pump up Vancouver’s housing market with loot. Wherever one looks, at the top it’s all bezzle all the time.

      They don’t care if their currency devalues relative to other currencies when it comes from the PBOC digital printing press. Just loot more.

  3. fosforos

    How can China be “devaluing” when world currencies like pound and euro are falling? And how can China be “overproducing” solar panels when the world has a crying need, now and for the foreseeable future, for every solar panel that can possibly be produced?

    1. Yves Smith Post author

      Please click through to the Telegraph article. China has depreciated the value of the renminbi on a trade-weighted basis.

      The fact that you think everyone needs solar panels does not mean everyone is buying them. If you are producing well in excess of demand, that is overcapacity.

      1. washunate

        Can you explain why you see that as bad? Why does it matter whether a national currency unit rises or falls in value relative to other stuff like foreign currencies and precious metals? It’s just accounting entries; it doesn’t matter whether it takes 1 quatloo or 2 quatloos to buy 1 euro. Fiat currency has no connection to real things; it’s entirely intellectual. This is the whole point, to divest monetary policy from the real physical world rather than connecting it through gold, silver, copper, wheat, salt, whatever.

        Evans-Pritchard seems so tied up in knots as to be almost purposefully obtuse. One moment he’s blaming Germany for keeping the eurozone exchange rate fixed with Italy rather than letting Italy devalue its currency, the next moment he’s complaining about China doing exactly what he wants Italy to do. Coming out of a UK that demanded keeping its own currency unit, attacking China strikes me as remarkably hypocritical.

        In your opinion Yves, if China abandoned the peg to the dollar, do you think the renminbi would appreciate or depreciate? If Italy abandoned the peg to the euro, do you think the lira would appreciate or depreciate?

      2. NeqNeq


        When you say that production is in excess of demand, do you mean demand at a certain market price or demand at Chinese factory costs?

        If the latter, can you provide a link to the empirical data on that? If the only way to sell the solar panels is to price them under cost, then there might be a case for claiming overcapacity. The question then becomes whether there is a social/environmental argument which overrides the (merely) microeconomic one.

        The Telegraph piece only talks about the steel industry ‘overcapacity’. That overcapacity is with regard to historical market prices. And so the case has to be made for China leaving the market as opposed to other (higher cost) companies.

        While cheap steel from China has been bad for UK and AU steel workers, the worker is not the focus in AEP. It is the concerns of management, who are losing market share and the concerns of investors who put their money in those companies (or playing the commodity markets).

        I always get the sneaking suspicion that the vague China panic articles are really just an example of ‘opinion makers’ talking their book. Perhaps (or maybe hopefully is a better word?) I am being overly cynical.

        1. Left in Wisconsin

          “Chinese overcapacity” is a tricky notion. The world is awash in excess steel capacity and virtually all of the capacity added in the last decade (three decades?) is in China. Yet one could argue that, since the Chinese capacity is low cost, none of the world’s excess capacity is in China. On the other hand, if national capacity is supposed to bear some relationship to national demand, then a large portion of the world’s excess capacity is Chinese.

          This is simply a replay of what we saw in the auto industry once the Japanese companies (in the 1970s and early 80s) and then the Koreans realized they could add capacity virtually without limit because all the new capacity they added was lower cost than US or western European capacity, with the difference being operating costs in Chinese are that much lower.

          1. NeqNeq

            I think you grasped one of my concerns fairly well. I am curious, however, about the national-demand link to capacity.

            I would have thought that no link was necessary given the roughly Ricardian conception of trade which grounds most of the thinking by our trade officials and advocates (who are bleating about Chinese steel too). At best it would be concerns over anti-dumping agreements… But I am not sure if it meets the conditions for dumping.

            Am I missing the rational?

    2. RBHoughton

      I live in Hong Kong and pop over the border once a month to sacrifice a Peking Duck. The exchange rate this last week has improved from my perspective by 4-5%. Formerly we were getting RMB82 per HK$100 but this week its 86.

  4. hemeantwell

    I’m left wondering about the way this conceptualization stresses “exporting deflation.” Couldn’t this also be thought of as something like “undercutting competing international firms by using currency valuation as an across the board pricing mechanism”? The emphasis on deflation seems to lose track of the competitive intent. ?

    1. OpenThePodBayDoorsHAL

      There’s lots of “received wisdom” informing the thinking on what we “should do”.
      We’re told “protectionism BAD, global free trade GOOD”. But good for whom, precisely? 1% rent-seekers and their shareholders? Or the 99% who work for them? The US has one of the highest standards of living in the world…so let’s “level the playing field” with countries with much lower standards of living?
      In the halcyon days of growth in the US economy in the 19th century it was acknowledged that high tarfiffs of course were the way to go. Depends if you want a strong and prosperous nation, or a strong and prosperous tax-dodging global rentier class.
      Then there’s the received wisdom that deflation is the most horrible thing in the world. I don’t know about you but I wouldn’t mind it if things got a whole lot cheaper. And please don’t try and tell me I will “forego purchases”, my doctor, landlord, grocer, school administrator, utility supplier, and gas station attendant unfortunately will not wait for payment.

  5. Chauncey Gardiner

    Thanks for this post and the link to Evans-Pritchard’s insightful article. Agree that China’s yuan devaluation policy will likely add to deflationary pressures.

    Yuan devaluation ties into China’s excess production capacity and attachment to a mercantilist economic model, but as he mentioned it’s not just China that’s attempting to suppress its currency exchange rate in an effort to boost exports. Currency manipulation by other major sovereign players is ongoing, with negative bond yields on government bonds out beyond 15 year bond maturities engineered by the ECB/EU (Germany) and BOJ/Japan that are depressing the currency exchange rates of the euro and yen. Also left unstated is that there are influential constituencies who benefit financially from related low interest rates and carry trades.

    Then there’s the enigma of Li’s evidently being sidelined from a prominent role in charting China’s economic policy; as well as China’s efforts to increase exports through development of organic growth in emerging markets.

    Further, the Obama administration’s ineffectual jawboning at the last G20 leaves an ordinary citizen wondering whether they are quietly pleased with the present and anticipated state of affairs, as no substantive policy prescriptions have been floated or even suggested other than their so called “trade agreements” with their ISDS provisions transferring sovereign power to transnational banks and corporations.

    And what form might effective policy prescriptions take, and what supranational organizations might lend themselves to their development?

  6. Larry

    I think we get very little insight into political and labor unrest in China, but I see this policy as buying political stability for as long as possible. Keep people employed overproducing and make it cheap enough with currency manipulation so that everybody can keep on buying. Leadership in China will face a major catastrophe if unproductive industries are wound down too quickly and masses of people find themselves unemployed. It really begs the question, what other policy choices to Chinese leaders have?

  7. NeqNeq

    So for those in US,UK, and certain other western European areas, the cost for any particular good manufactured in going down due to both exchange rate and factory gate price (and shipping given the doldrums that sector is seeing).

    Does that sound about right to everyone? Is stuff getting cheaper relative to your wages?

    1. Left in Wisconsin

      Declining company costs do not always mean declining consumer prices. I know, shocking.

      1. NeqNeq

        You are absolutely correct.

        I was trying to get a sense of how the word ‘deflation’ was being used. If prices are going down for firms, but not consumers, then deflation isnt used in a CPI sense. It isnt clear to me that its meant in a monetary sense given the exemplar used, but that is the other frequently used meaning of the word.

        If its neither of the two above, then what are we talking about? And why couch the problem in unusual definitions? The cynic in me says that its a ploy pulled from Larry Summers playbook: use scary words in ways that are highly unusual so as to obfuscate the real meaning of what I am saying. Usually used for rhetorical/marketing purposes. (Ie Recession….when he means a slowing in the rate of growth). I am asking questions, though, because intuition is often inaccurate.

  8. Schofield

    Who needs nuclear weapons when you can use “smart” understanding of money as a weapon?

  9. Ben

    The yen has been devalued in last few years by significant extent, at one stage some 20 plus percent. In comparison, rmb devalued against usd by few percent last one year. Don’t you think you are barking up the wrong tree?

    1. Ben

      Also, the euro has been swinging some 20-30% against usd since the financial crisis. During this period I believe the rmb has net rise of at least a few percentage points against usd.

  10. washunate

    The Telegraph’s Ambrose Evans-Pritchard has warned for some time that if China were to devalue the renminbi, it would add considerably to already dangerous deflationary pressures.

    Our language in the English speaking world for these things has become notably vague and imprecise. It’s rather dishonest, to the point of calling into question his entire worldview, to one moment suggest that Italy could be stronger outside EMU and the next moment lambast China for allowing its currency peg to fall against the dollar – especially coming from England whose currency has depreciated rapidly recently. As far as deflationary pressures, that makes no sense. We have a world where, in aggregate, prices are too high, not too low.

    So which is it? Does Pritchard support freely floating exchange rates, or fixed exchange rates? Because the euro, internally, is a fixed exchange rate system, while if China unleashed its currency peg in one fell swoop, the likely short-term outcome would be depreciation, not appreciation.

  11. denis

    I have great respect for Hans’s views, but Japan’s biggest imports are Crude Oil and it’s byproducts none of which comes from China, but from the ME and the US-Canada. It’s second and third imports are electronic equipment and machinery about which China barely registers. The biggest imports of Japan from China has been labor and that has been eroded due to dramatic wage increases in China in the past 5 years.

    China is most competitive in low end consumer products, and new tech oriented businesses. Neither Germany nor Japan face any direct competition from China in their main industries. Labor has been the strength of Chinese exports and that is now practically over. When one takes into account the exchange rates of major currencies and the wild gyrations and the devaluation of most currencies by 20 30 percent in the past year and this one while the RMB was appreciating, China looks more of a victim of a trade and currency war rather then an instigator of deflation.

    Deflation it’self is a whole new subject. Suffice to say i doubt any one here including some well to do people :), have experienced or are experiencing deflation in their lives. Rather the opposite. From equities to housing and services healthcare and education, food etc, all have experienced dramatic price increases, regardless if they are calculated in the CPI or not, in the end of the day it is what matters the most, to consumption, because the more one spends in these the less they have to buy cheap Walmart tablets from China, and thus add to the “deflationary” pressures that the west complains about.

  12. Cry Shop

    China’s being hammered this summer, by the weather, and by large currency outflows. The former is really hurting the poor, as is always the case.The later is boosted by fears over Xi’s incompetence in economic thinking and love for grandiose gestures that often run rivers of red ink.

    China may be exporting deflation, but they are importing inflation for foodstuffs and other necessities at a time when the poor probably can least afford it. It’s going to get interesting.

  13. Jim Haygood

    “US Treasury has also failed to deem China a currency manipulator in its semi-annual certifications even though there have been periods when the designation unquestionably fit.”

    In a world of fiat currencies with no redeemable value, ALL issuers are currency manipulators.

    This is a case of a whoremongerer condemning an adulterer for moral turpitude.

    “It’s okay when we do it.”

  14. Fiver

    While long a critic of China’s explosive growth for several important reasons, I have a lot of trouble with AEP’s tone after the performance of the BoE, Fed, ECB, BoJ et al focused on banks and levitating ‘markets’ while the economies in which they are anchored were as saved (if temporarily) by mammoth Chinese stimulus as the Chinese themselves. They could quite justifiably point at the US and Europe as having completely dropped the ball re a true global recovery by adopting fiscal austerity, upturning the entire Mideast, and picking a fight with Russia.

    In any event, China has a huge mess on its hands, and has to do this right. But I fear for some time now that China’s problems look more and more like big opportunities for US and Western financial/power elites. The stakes for China are now vital, mortal even existential as a State or independent China if its leadership fails here. As it happens, I think China cannot afford to fear substantial short-term ‘unemployment’ so long as it provides an effective net. After all, if we take a reasoned look around our own economy, it’s evident most of what we do is just stuff we’ve made up to keep ourselves occupied and/or pleased – but it comes in historical chains of all lengths and complexity. If China wants to make the giant leap to sustainable, stable, comfortable, it needs to find a billions ways to engage its people without turning them into incredible resource hogs like us.

  15. Russell

    If you want to simplify currency matters you have real financial engineering using real-world models that compete now and ask these Petroski anointed financial engineers what currency numbers set by the world government create cooperation instead of inspiring war.
    I call them Petroski because I was unprepared to see him allow for finance as an engineering discipline.
    Currently I call the Wall St. “Financial Engineers” Meyer Lansky type financial engineers.
    Now let me be clear, to coin a phrase, I am aware there is no world government, only Rome,it’s affiliates and China. Or Rome as now America the Empire run by the military which sees war as the economic answer counting unlimited access to Treasury support regardless of any bothersome government interference with its imperative to expand power and borders. PS Boak Rome to 564

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