China Halts Yuan Appreciation: Another Currency War?

China's policy of gradual appreciation of its currency has been put on hold. Since the currency is not freely convertible, the authorities generally have a great deal of influence over the exchange rate. Just as China's growth was deemed to be at risk, such as during bouts of euro-zone-driven financial stress, the renminbi would flat-line or even depreciate against the dollar. Given that the renminbi strength puts China's exporters at a disadvantage (particularly when Japan has been in a devaluation mode) authorities are probably somewhat concerned. The fact that China's exports have stopped growing is obviously not helping.

Reuters: An unexpected slump in exports in June marked the latest worrying sign of a slowdown in the world's second-biggest economy, raising the prospect that regulators may be forced to drag the yuan back down after a massive rally this year.

Unfortunately for policymakers, while a weaker yuan might improve the price of Chinese goods sold abroad, it will not be the cure all for exporters. Other factors are driving up production costs at Chinese companies and undermining their competitiveness abroad.

Economic reformers at the People's Bank of China (PBOC) will come under pressure to use brute-force exchange rate manipulation to stave off a potentially destabilizing round of factory layoffs.

Liu Ligang, Greater China chief economist at ANZ bank in Hong Kong, said some sort of adjustment - including pushing the currency lower -- was likely as policymakers were behind the curve in dealing with a longer downturn in exports demand than expected.

"PBOC policy needs to be corrected according to the changed external environment," he said.

Of course this could further irritate a number of US politicians who are likely to raise the issue of China's controlled currency. A number of U,S. senators recently introduced legislation to allow the U.S. Department of Commerce to impose tariffs on those nations who are labeled a "currency manipulator". There will definitely be calls to include China in this camp. The U.S. Administration is also uneasy regarding this situation. On Thursday, U.S. Treasury Secretary Jacob Lew suggested that China should let its currency appreciate further.

Jacob Lew: "We have acknowledged that there has been progress in closing the gap, but we've also made it clear that there's still more progress that needs to be made in order to reach the point where there's truly a market-determined rate."

Heightened Tension
While halting the appreciation would be unwelcome in the U.S., a depreciation, as suggested by the Reuters story above, would certainly heighten tension between the two nations. But China has its domestic priorities and unless exports improve soon, currency "adjustment" could become China's tool of choice.
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