China's sudden currency devaluation is a sign of the country's weakness
The change is designed to give the flagging Chinese economy a boost. There's a lot of disagreement about how fast China is growing, but there's almost total consensus that the rate of growth is definitely slowing.
A cut will give China some advantage over its trading partners, since Chinese goods will now be comparatively cheaper.
Unlike other major global currencies, the yuan is tightly controlled by the Peoples' Bank of China (PBoC), though less tightly than it once was. The PBoC sets a band in which the currency is allowed to trade. As M&G's Bond Vigilante's blog notes, Beijing also introduced more flexibility into the yuan's value too.
In general, the PBoC's interventions in the last decade have meant a stronger yuan, not a weaker one.
In fact, in the last 10 years it's the dollar that's fallen against the yuan - it's down by 25%:
The cheapness of the yuan relative to the dollar was a constant complaint of US politicians and manufacturers for many years - they said China's weak currency was losing them industrial output and jobs - but if that was ever true, it's far less so now. Even since 2011, China is the only major currency that the dollar has depreciated against.
Here's Kit Juckes of Societe Generale in his morning email, laying out just how much other currencies have depreciated in comparison to the yuan in recent years:
Over the last two years, since the Taper Tantrum summer, CNY has dropped 3% against the dollar, but the yen's fallen 23%, the Euro 18%, and other Asian currencies have fallen by between 5% (INR) and 25% (IDR). Relative to those moves, the Chinese adjustment is a token move that won't do anything to stop the economic slowdown...
In real terms, the CNY has gained over 50% against all three of the other BRIC currencies in the last decade. It's valuation has looked increasingly unsustainable as the others have seen their currencies tumble, and the 1.9% adjustment today is far too small to change that.
Deutsche BankOnly one major US trading partner's currency has not depreciated against the dollar since July 2011.
It's another move by a central bank that will have some people worried about "currency wars," the buzzword for countries engaging in competitive devaluation. By definition, some countries must have stronger currencies so that others can be weaker in comparison, and not everyone can devalue at the same time. There are some historical parallels for that sort of behaviour.But China's devaluation may have other effects that don't work through trading with other countries. Economist Lars Christensen gives a good breakdown of the domestic effects a devaluation can cause here. In short, it can boost the supply and velocity of money and offer an internal boost to demand even without the positive effect on exports.
But given the scale of other countries' devaluations and the fairly limited benefit it's offered them, it doesn't seem like most analysts expect a dramatic recovery in China's economic fortunes.