Surprise Devaluation

In a move sure to heighten trade tensions with protectionists in US Congress, Surprise China Devaluation Marks Escalation of Currency War.

According to conventional wisdom, wars are easy to start and difficult to end. Similarly Beijing's devaluation, the biggest one-day currency move since 1993, represents the latest skirmish in an emerging battle which, analysts warn, may be hard to reverse.

"This shows how desperate the government is over the state of the economy," said Fraser Howie, a China analyst and co-author of Red Capitalism. "If they were trying, as the central bank said it was, to bring the exchange rate back into line with market expectations then they have failed miserably as the market is now just expecting further devaluation."

In late March, Chinese Premier Li Keqiang told the Financial Times: "We don't want to see further devaluation of the Chinese currency, because we can't rely on devaluing our own currency to boost exports.

"We don't want to see a scenario in which major economies trip over each other to devalue their currencies," Mr Li continued. "That will lead to a currency war, and if China feels compelled to devalue the RMB in this process, we don't think this will be something good for the international financial system."

Another problem is that depreciation is likely to exacerbate capital flight, which has already become a serious issue this year for the first time in more than a decade.

"The devaluation in the renminbi is not large enough to improve China's export competitiveness, but it is large enough to create a sense that Beijing may have fundamentally shifted its currency policy," said Stuart Allsopp, head of country risk and financial markets strategy at BMI Research.

"The risk now is that investors see the yuan [another term for the renminbi] as a one-way bet weaker and start to position against the currency, raising the prospect of more substantial yuan weakness and more economic uncertainty."

Yuan vs. US Dollar

That may not look like much but it is a surprise 2% move. And it comes amidst a persistent trade deficit with China.

I talked about the trade deficit on Sunday, in China's Exports Plunge 8% in July; Spotlight on US Trade Imbalance With China.

Will protectionists in US Congress again threaten China with potential legislation to label China a currency manipulator?

They shouldn't, but I expect the howls any minute now from Congress, the steel industry, and others.

By the way, this desperate move by China's central bank is more proof of the weakness of the entire global economy.