By Fran Howard
In an effort to shore up its sagging economy, China devalued its currency last week by allowing the yuan to float against the U.S. dollar. This will make Chinese exports more competitive in world markets, while at the same time making imported products—including milk powders— relatively more expensive for Chinese consumers.
“Historically, the People’s Bank of China has set a daily rate for the yuan relative to the U.S. dollar and allowed the currency to trade within a 2 percent range,” says Sarina Sharp, agricultural economist with the Daily Dairy Report. “Recently the U.S. dollar has strengthened, and a strong currency may be more appropriate for the United States than for China given what’s happening in the countries’ respective economies.”
In recent news reports, Yi Gang, vice governor of the People’s Bank of China, said: “A fixed exchange rate looks stable, but it hides accumulated problems.”
Some analysts have speculated that the bank’s move indicates that China’s economy could be far weaker than thought.
“Some traders speculate that the decision by the People’s Bank of China to allow its currency to devalue is just the latest in a series of measures meant to stimulate the economy,” says Sharp.
No doubt, a weaker yuan could help struggling Chinese exporters sell more goods overseas—if world economies don’t fall victim to China’s sagging currency.
“If Beijing allows the yuan to decline further in coming months, it could increase trade tensions, or even a ‘currency war,’ in which the world’s big trading blocs face off in a beggar-thy-neighbor battle to seize the largest possible share of global consumer demand,” says a recent article in The Guardian.
Both copper—a bellwether of global economic health—and crude oil futures dropped to six-year lows following the move, notes Sharp. The weakening yuan also dragged the U.S. dollar index lower, which pushed the dollar to a one-month low against the euro.
“This is an unwelcome change for milk powder merchants in Europe who have a lot of product to unload,” Sharp notes. “As their competitiveness erodes, they could send even more powder into public intervention storage than previously planned.”
U.S. exporters have gained a slight advantage over their European counterparts based on the recent currency moves, but there are still large global stockpiles of milk powders and limited demand from China, notes Sharp.
If the cheaper yuan reduces the price importers pay for Chinese goods, inflation will continue to be undermined. Low inflation—or worse deflation—could delay increases in interest rates on both sides of the Atlantic.
“If, however, the Federal Reserve Bank signals a willingness to raise interest rates, the U.S. dollar could quickly gain on the euro, erasing any advantage that U.S. exporters might have had in the cutthroat competition for global milk powder sales,” says Sharp.
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