Updated Jul 11, 2018

China's currency drop helps exports but comes with risks

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Data: Money.net, China Foreign Exchange Trade System & National Interbank Funding Center; Chart: Harry Stevens/Axios

Since the middle of June, China’s currency — the yuan — has fallen more than 3% against the dollar, and by a bit less against the currencies of China’s main trading partners. After a particularly large drop last Monday, China is reported to have intervened to limit the yuan’s fall.

Why it matters: Few prices matter more to the global economy — or to global trade — than the value of China’s currency. A weaker yuan supports China’s exports and generally pushes down the currency values of countries that compete most intensely against China in global markets.

The background: China manages its currency, so changes in its value never reflect just the moves of an unfettered market. But it isn’t clear if the yuan’s recent depreciation stemmed from a swing in market consensus — i.e., that China’s currency needed to fall because of economic slowdown and pending U.S. tariffs — or from a conscious decision by China’s government to weaken its currency to support its exports ahead of the tariffs.

The yuan’s recent depreciation reversed a period of appreciation earlier in the year, but it hasn’t pushed the currency below its average 2017 levels. China’s reported intervention could signal a new commitment to bolstering its currency, or it could simply reflect concern about the speed of its depreciation over the past few weeks.

The big picture: On one hand, a weaker currency gives China a way of retaliating against the U.S. even after it maxes out on its ability to match U.S. tariffs dollar for dollar. On the other, additional depreciation might invite Trump to accuse China of starting a currency war — and it also runs the risk of triggering a reprisal of the capital outflows that followed the yuan’s surprise depreciation in 2015.

What’s next: It’s too soon to tell. China still has plenty of reserves, so it could block further movement in its currency, but it may not want to: On currency, unlike with tariffs, the ball is clearly in China’s court.

Brad Setser is the Steven A. Tananbaum Senior Fellow for International Economics at the Council on Foreign Relations.

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