The central bank has shifted the central peg of its dollar band twice this
week in a calculated move that suggests Beijing aims to offset the
precipitous slide in Chinese manufacturing by trying to gain further export
The futures markets are pricing in a 6pc devaluation over the next year. "This
is clearly a big shift in policy and we are now on alert," said Simon
Derrick, currency chief at the Bank of New York Mellon.
The move follows a Politburo speech by President Hu Jintao warning that China
is "losing competitive edge in the world market".
China has allowed a crawling 20pc revaluation over the past three years. Any
reversal risks setting off conflict with the incoming team of
President-Elect Barack Obama in Washington. Mr Obama called China a "currency
manipulator" during the campaign, a term that carries penalties under
US trade law.
Outgoing US Treasury Secretary Hank Paulson is viewed as a "friend of
China". He called for a stronger yuan this week before embarking on a
visit to Beijing, but the plea was couched in friendly terms. This
soft-peddling may soon change.
Hans Redeker, currency head at BNP Paribas, said China's policy switch could
set off a dangerous chain of events. "If they play this
beggar-thy-neighbour game, it will cause a deflationary shock for the whole
world," he said.
It makes sense for countries with current account deficits such as the UK, US
or Turkey to let their currencies fall, but China has the world's biggest
Michael Pettis, a professor at Beijing University, said it was "very
worrying" that a pro-devalulation bloc seemed to be gaining the upper
hand in the Communist Party. "I really do believe that we are on the
brink of a very ugly period for trade relations," he said.
China has relied on exports to North America and Europe as its growth engine,
making it acutely vulnerable to the contraction in global demand. Mr Pettis
said this recalls the role played by the US in the 1920s, a parallel fraught
with danger. "In the 1930s the US foolishly tried to dump capacity
abroad, but the furious reaction of trading partners caused the strategy to
misfire. China already seems to be in the process of engineering its own
Smoot-Hawley," he said, referring to the infamous US Tariff Act in
China showed restraint during the Asian crisis in 1998, holding the line
against domino devaluations across the region. It may yet hold the line this
However, this crisis is more serious. The manufacturing sector has seen the
steepest decline since the records began, with devastation sweeping the
textile, furniture and toy sectors. Civil unrest has begun to rock the
Guangdong and Longnan regions.
Beijing has slashed rates and unveiled a fiscal stimulus of 14pc of GDP, but
most of the spending comes in the form of instructions to local governments
to spend more – but without giving them the money. Does China really intend
to step in to prop up global demand? The jury is out.