Talk of global currency war is greatly exaggerated
Much of the focus last week was on China, firstly on a place and then on a person that many of us knew little about. The place was Tianjin, one of the world’s largest ports and the person was Zhou Xiaochuan, the Governor or the People’s Bank of China (PBoC).
The tragic events in Tianjin are being covered extensively elsewhere, but before dealing with more prosaic matters I want to acknowledge the human cost for those who have lost loved ones and homes. In all of the mystery and speculation surrounding the explosions, it would be all too easy to forget the sad consequences for the residents of Tianjin.
Many of us know little of Tianjin and for some of us last week may have been the first time that we had heard of this metropolitan area in China, which has a population in excess of 14 million. To put this in context, the UK has only three urban areas with a population in excess of two million. China has more than 40 cities with populations of over two million and the country is no longer isolated in the way it once was, so it is hardly surprising that political and economic events in China now have such a huge global impact.
Last week, under the guidance of Zhou Xiaochuan, China made its biggest reform to foreign exchange policy in a decade, resulting in an almost immediate devaluation of nearly 2% to the Chinese currency.
The move took most analysts by surprise and there was an immediate impact, leading to a sell-off in most major equity markets. At one stage the FTSE 100 was down 2.75% and the DAX in Germany 4.87%. The Dow Jones Index also fell but recovered relatively quickly. With the thin trading at this time of year, the impact was probably a little exaggerated, although a devaluation in the Chinese currency is undoubtedly negative in the short term for most companies outside China.
What was also likely to have been exaggerated was the talk of a ‘currency war’. The trade-weighted value of the Chinese currency has seen a sharp increase over the past year and, in reality, the devaluation merely takes back a little of that increase. Modern Chinese technocrats seem to prefer evolutionary change to revolutionary change.
The PBoC is clearly adopting a more market-based mechanism. In the coming week there will be considerable attention on how the PBoC manages its exchange rate system, even though the impact on global financial markets is probably already waning. The change in the currency system is an important step towards the floating exchange rate recommended by the International Monetary Fund and should give China more flexibility in its monetary policy.
Meanwhile, as we monitor the global impact of China on world markets we should also continue to remember what is more important, namely the people of Tianjin and what they face over the coming months and years in dealing with the fall out of the devastation wreaked by the explosions.
Jeremy Stewart is head of wealth management and private banking at Danske Bank