Currency Devaluation an Option for China to Return to Growth

Currency devaluation is China’s last and only realistic choice, in my view. A currency devaluation of 10-15 percent would stimulate export growth and foster inflation that could ease the deleveraging process. Of course a devaluation of this magnitude would send shockwaves through financial markets, but in the medium to long run it appears to be the most probable path.

On the other hand, there is a long-term argument for a stronger currency, especially as China shifts toward consumption. A stronger Chinese currency would give Chinese citizens more purchasing power that could increase consumption of foreign goods. In my view, it is this competing argument that has caused China to commit a monetary policy error.

The competing arguments on the proper direction of the yuan, coupled with capital flight have forced China to defend its currency. By defending its currency, China is actually conducting quantitative tightening (QT) and this contractionary policy has created an ugly deflationary deleveraging that is now washing up on U.S. shores.

The term “ugly deleveraging” was coined by Ray Dalio of Bridgewater and, in my view, accurately describes the current situation. In an ugly deflationary deleveraging, very few asset classes do well, typically commodities and equities fall while bonds rise.

via CNBC

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