Today, the Wall Street Journal reported that the Chinese Central Bank engineered the decline of the nation’s currency, the yuan. The central bank did this by setting a weaker trading benchmark against the yuan, and by having Chinese banks buy dollars.
In his article, Keith Bradsher of the New York Times reports on the rise in Chinese exports despite decline of the economy. Another New York Times writer, Anatole Kaletsky explores the conflicts of interest in the decline of China’s economy. The country is moving towards stronger bank lending, but officials want to reduce credit growth.
All of these can be looked at from a monetary perspective. The decline in the nation’s currency is related to the growth in exports. When a currency is weak, goods and services for the respective country are cheaper to the rest of the world. This will cause an increased demand for these Chinese goods and services that are cheaper than domestic goods and services in the countries trading with China. Furthermore, when the Chinese currency is cheaper, foreigners will want to buy Chinese assets because they can purchase a lot for a little of their own money. With this increased interest in currency, asset values rise. This means that the people who bought the Chinese assets when it was cheap made money from this appreciation in the yuan. It is like an investment. With the Chinese central bank engineering a decline in the currency. Those who purchase Chinese assets would be losing money.
This engineered decline is part of the reduction in credit growth. When the currency continuously decreases, foreigners will not want to purchase Chinese assets. This will cause a decrease in investments. When this happens, the country will experience a credit crunch. This could potentially start a credit crunch.
I am not in favor of the Chinese central bank engineering this currency decline. Yes, it will cause increased interest in investment in the country. However, continued decline in the currency will decrease the returns on purchasing Chinese assets. This loss of interest will decrease the value of the yuan further. It could get to the point where the currency becomes nearly worthless. Chinese assets could lose their worthless. This could add to China’s economic woes, and the country could potentially sink into a depression and a financial crisis. The government would have to stop engineering this depreciation of the currency after a certain point, so investors will not pull out due to the growth in their currency investments.