The Shot Not Heard Around the World
China’s recent move to devalue the yuan has sent shock waves through the global financial markets and has convinced most observers that a new front in the global currency wars has begun. The move has caused many observes to envision a new round of competitive devaluations around the globe in which the race to the bottom will intensify. In this scenario they envision that the U.S. dollar will solidify its standing as the only strong currency. This misses the point entirely.
In the past, most of the action in the “currency wars” had been focused on the efforts that many nations undertook to prevent their currencies from rising against the U.S. dollar, which itself was being weakened by a perpetually easy Federal Reserve and persistently negative U.S. trade and budget deficits. But with the dollar now strengthening significantly, the Chinese government has become concerned that the yuan, which has remained largely tethered to the dollar, had become too strong against other currencies, particularly its primary trading partners in Asia and the Pacific. To remain competitive locally, it decided to ease the tether to the dollar and instead let its currency float more freely. The purpose and implications of this significant pivot has largely escaped the U.S. media. In reality, the move raises the likelihood that the yuan will rise significantly when the dollar resumes its long-term bear market, not that it will remain weak forever.
It is surprising how quickly market observers ascribed the recent losing streak on Wall Street to jitters over the 2% yuan devaluation. The development provided a convenient excuse for those who continue to deny that any economic weakness in the U.S. is chronic and self-generated. But why should America be so concerned with a small drop in the yuan? After all, we have supposedly done quite nicely for ourselves economically even while currencies like the yen and the euro, and all the other major currencies around the world, have fallen more than 20% against the dollar since May of last year.
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