Opinion | How yuan devaluation inflates China’s liquidity bubble and kicks structural reform down the road

Andy Xie says the trade war is an opportunity for China to make long-overdue economic changes, such as tax cuts, rather than resorting to pumping in liquidity yet again

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Published: 2:00am, 9 Aug 2018Updated: 9:48am, 9 Aug 2018

China’s renminbi is declining precipitously, down by 6.3 per cent since mid-June and about 10 per cent since April. In the same period, interbank interest rates have fallen sharply. The combination implies that the currency movement is a result of monetary policy change, not external factors.

There is a strong case to be made that China is devaluing the renminbi by choice in response to the trade war with the US. If devaluation is to be the main tool for blunting the impact of the trade war, there could be a lot more to come.

While there are many arguments as to why China should do this, the result would be to pass all the costs of the trade war to the household sector by depressing households’ real income and purchasing power. The government and the state-owned enterprises won’t adjust. Hence, the economy will become more unbalanced. This lays the seeds for more conflicts with China’s major trading partners.

The trade war has increased uncertainty about China’s future. The risk premium on buying from or investing in China has shot up. While some countervailing economic measures are needed to stabilise the situation, these measures shouldn’t create bigger problems down the road.

Investors or buyers are not foolish. If they think that the stabilisation measures would worsen the problems eventually, why would they pay much attention to their short-term stabilising impact? Devaluation is like that. It may induce a sugar high temporarily, but the situation will worsen later.