Devaluing currencies from the US to Japan, Eurozone and China. Although Japan started zero interest rate policy back in the mid-1990s, for a more relevant comparison, we start the analysis post-2008/9 crisis.
The Fed's ZIRP began in December 1998, before heading off QE in March 2009, followedby QE2, Operation Twist and QE3 in the ensuing four years. As a result, the USdollar index fell more than 18% on two occasions; in 2009 and in 2010-2011 witha brief pause during the eruption of the Eurozone debt crisis.
Fed in 2009
Japan finally succeeded in combatting yen strength by voting in a new Prime Ministerwho's campaign was largely based on yen devaluation with the blessing of theIMF aka the US. Thanks to two waves of QE in 2013 and 2014, the Bank of Japan'sasset purchases extended beyond government bonds to corporates and equity funds.The result was a 32% decline in yen's trade-weighted index and a 60% plunge againstthe US dollar.
Japan in 2012
In March 2015, the European Central Bank inaugurated a full scale €1.1tnQE program, at the tune of €60.0 bn in monthly purchases of public and privatesector assets until September 2016. The program aimed primarily at reversingdeflation and easing financial conditions to revive growth in most recessionaryEurozone members.
Eurozone in 2015
This week, the China reported the 9th consecutive monthly decline in imports(longest since 2008-9), the 5th decline in exports over the last seven monthsand a 7% decline in China's currency reserves to a 2-year low. With most businesssurveys indicating a contraction, China's economic situation was exasperatedby pegging its currency to the appreciating US dollar. After weakening the yuanby nearly 3% earlier in the year, the People's Bank of China reversed coursein March to stabilize escalating capital outflows. But the rising dollar madethings worse.
China in 2015
Yesterday's yuan 1.9% devaluation and today's subsequent 1.5% decline means that 5% depreciation is inevitable. Any devaluation greater than 7%-10% would be a serious threat for global markets and China's trading partners. Let's not forget the CNY appreciated 11% after the 2008-9 crises and that it remains overvalued by most measures following the appreciating USD and deepening slowdown in the China.
A CNY decline of such magnitude could occur if China mismanages the balance between maintaining CNY competitiveness and curbing capital outflows. Another risk to such balance would be renewed Chinese data disappointments and prolonged USD appreciation. The likelihood of all this materializing is about 40%.
With regards to accusations against China continuing to manipulate its currency, it is a fallacy to confuse China's lack of full currency convertibility with undervaluation. This is no longer 2005 or 2006, when minimal revaluations were dwarfed by China's expansion. The currency may not fully function according to perfect market forces, but it has appreciated more than 10% against the US dollar between summer 2010 and winter 2014. During that time, China GDP slowed from 10% to 7%, exports fell from a rate of +30% to -8% and credit growth plummeted. The IMF and most economists deem the yuan to be overvalued against the US dollar.