The dragon stirs

This year however we can take a pretty good guess what was on the agenda. On Tuesday, China shocked the world's markets with its effective 1.9% devaluation of its currency the renminbi (also known as the yuan), jerking global markets out of their summer doze and prompting a round of hand-wringing about the prospects of a sustained currency war on the global recovery. The move was followed by two consecutive days in which the Peoples Bank of China set the guiding rate for its yuan currency lower, albeit by smaller degrees.

For some this meant war. Currency war and trade war. At a time of low commodity prices and weaker emerging markets, some observers feared a wave of deflation washing around the world.

In fact, in the scale of currency devaluations, 2 per cent is no big deal. Harold Wilson devalued Sterling by 14 per cent in 1967 and Argentina cheapened the peso by 39% in 2002. So why then was the BBC's economics editor Robert Peston arguing that the move will have "global ramifications" that could dwarf the Greek crisis. Coinciding as it did with the literal, fatal, explosion in Tianjin, it was in one characteristic tabloid headline "the financial crisis in China that could plunge the world into meltdown."

Partly it is because markets have been nervous about the Chinese "slowdown" for many months, as have the most seasoned China-watchers: “China is more than ever characterised by confusion, contradictions and concerns” the consultancy Asiawatch wrote in May, observing that while nominal growth in the economy had collapsed from 20 per cent year on year to in 2011 to just 6 per cent this year, while in the last year the Shanghai Composite stock market index had doubled (it has since fallen back by over 20 per cent).

The $10 trillion economy, the world’s second largest, has been in transition towards a consumption-led model for some time. In the process growth has been struggling to meet the official 7 per cent target this year, largely because of a decline in manufacturing and a slump in exports, which fell a massive 8.3 per cent in July, yet to be compensated for by the rise in domestic consumption that China's leaders have been struggling to engineer.

Against such an unsettled background any sudden move by China could easily be portrayed in the mind of the market as the trigger for something catastrophic, and this week's move was inevitably interpreted as a rare sign of panic from the dark-suited mandarins, including President Xi Jinping; the prime minister, Li Keqiang, gathering for their seaside rendez-vous.

“China, on Tuesday, became part of the problem, not the solution” says Dr Jim Walker, the veteran Scots China-watcher, and ex-RBS economist, whose Hong Kong-based consultancy Asianomics has made him the high priest of Chinese economic rune-readers, and anything but a panic-merchant. To him the significance of the move was more in what it portends for the future.

“The truth is, a 1.9 per cent devaluation hardly constitutes a devaluation at all. The yen and euro have had bigger daily moves on countless occasions over the last two years."

Walker believes that depreciation marks a sea-change for China, in that it is now aligning its exchange rate policy with its fiscal and monetary moves, and telling the world that it cannot look on a dollar-pegged renminbi as a “rock of stability”.

The Asianomics analysis is that current conditions in China call for an easier monetary policy, and that is what a weaker renminbi provides.

"It made no sense at all for China to be talking monetary and fiscal easing while pegging its currency to the strongest exchange rate on the planet [the dollar]. All that did was neuter domestic monetary easing moves, regardless of how ineffective they might be in the current environment. So, at least now all of the policy levers are supposedly in the “on” position.”

If this does make sense, why the tumultuous market reaction? Probably because devaluation is a game that is easier to start than to stop. This week's micro-devaluations in themselves will do little to restore China's competitiveness. But they do give a clear indication that the renminbi is going to fall, leaving everyone speculating about how far.

Or as Walker sums it up: “The Chinese government is good at direction but terrible at magnitude”. There is legitimate concern that Beijing may have prompted a region-wide race to the bottom, a fear given credence by knock-on devaluations of Asian currencies like the Korean Won and the Indonesian Rupiah.

Lying behind the question of how worried we should all be about the People's Bank of China's moves is the question of how worried should we be about the Chinese slowdown in general. Much of this depends on perspective.

On one level the anxiety is understandable. Growth of 7.4 per cent in 2014 was China’s weakest growth in 24 years, also the first time this century that China has missed its official growth target, falling just short of the official goal of 7.5 per cent.

On another level, obsessing about such stats looks excessively pessimistic. In the same year, China achieved the feat of exclusive club economic output exceeding $10 trillion, making it only the second country to achieve this after the US reached this level in 2000.

At market exchange rates, China’s economic output was $10.3 trillion last year, more than five-times bigger than a mere decade ago, when it was $1.9 trillion. This gargantuan size means that a minuscule downgrade in a rate of increase is neither here nor there, as slower growth now generates as much additional demand as its turbo-charged growth did just a short time ago.

Last year’s "slow" growth yielded an extra 4.8 trillion yuan (£480bn) in GDP, almost exactly the same as in 2007, when growth was 14.2 per cent and inflation higher. Also, the current Chinese economy is far more service-oriented than it was then, and more high-quality urban jobs are being created.

According to the PwC economist Andrew Sentance, a former Bank of England MPC member, we should not be too worried.

“I don’t think that a slowdown in the Chinese economy is in itself grounds for concern" he told the Sunday Herald. It couldn’t keep growing at the same pace, a slowdown to 5-6 per cent was on the cards, of itself it's not a bad thing, especially as takes pressure off energy and commodity and food prices. Anyway the Chinese economy needs to moved away from manufacturing and infrastructure to consumers.”

“What is worrying is that if it happens abruptly, that is something that could ripple through the global economy, the key issue is whether what we’re seeing now is just a bumpy phase in a gradual slowdown or if something more serious is on the cards.”

“China is not like a normal Western economy, it’s communist state with strong state control, and they need to change it to make it more flexible. But this does mean that for the time being the government does have levers on the economy that it can pull, and the fundamental problems like large budget deficits and current account deficits that other economies have are not present, which gives policymakers room to offset downward pressures.”

And the devaluations? “I suppose the timing was a surprise, but if you think about the pressures that China has been under it’s not that unexpected a move: the currency has been very stable against the dollar for the last three years or so and that stability is not sustainable in a world where the dollar has appreciated against the Euro and the Yen, which has made China quite uncompetitive as to where it was five years ago.”

Sentance notes that the Bank for International Settlements which measures real effective exchange rates for a wide range of currencies has found that China’s has increased by 30 per cent since 2010, half of that in this year, making a devaluation look inevitable.

Even if we can guess the subject of the Beidaihe conclave this year, we will probably never know the pressures and the political and economic trade-offs that were on the minds of China's quasi-communist madarinate that led to the currency drama. But despite the fears that this opacity gives rise to, not to mention the numerous strains and complexities of China's weird, hybrid economy, there is some consolation in the fact that Beijing has navigated recent global crises like the 2009 crash quite skilfully.

The only thing to worry about would be devaluation as a portent of a broader economic and political crisis, that would fulfill the pessimists' two-decade-long belief that the Chinese miracle that has been the engine of global growth was fated to go horribly wrong, with devastating global consequences. That day may come or it may not, but in the meantime: anyone for cheaper Chinese goods?

Financial fire-breathing

A complicating factor in the yuan devaluation story is China's effort to have the "redback" accepted as an international reserve currency alongside the dollar, the pound, the yen and the euro, symbolised by its being given "special drawing rights" (SDR) by the IMF in Washington. To do this, the central bankers must be convinced that the Chinese currency is subject to a more "normal" or market-determined exchange rate, and paradoxically, last week's forced devaluation is a comforting signal that the yuan is moving to a more market-determined exchange rate.

According to Jim Walker the Chinese state, is rattling its sabre out of pique at being excluded from the SDR club:

“China is now showing that the price for spurning its advances might have global consequences,” he speculates, though the move could be counter-productive: “Unfortunately, its very actions mean that it will be viewed with greater suspicion in the ongoing talks over the SDR basket".

“[Last week’s] move by China was not a demonstration of the increased flexibility that the IMF was looking for. It was the fury incurred by a lover scorned. China now intends to show the developed countries that it can damn-well do what it likes.”