Currency War? Cheap Chinese goods about to get cheaper

The Chinese central bank cut the value of the renminbi (yuan) by 1.9% sending other Asian currencies downward and making Chinese exports even cheaper for foreign consumers.

Australia, Singapore and South Korea saw their currencies drop more than one percent as speculators expect those governments to cheapen their currencies to keep the price of exports competitive with China.

The People’s Bank of China (PBOC) said that the cut is a one-time adjustment necessary in order to match their currency to the current market.

It’s hard to believe this will be a one-off adjustment. The race to the bottom just became a good deal more treacherous.

According to a Bloomberg report, PBOC is implementing a new market-based currency valuation mechanism:

Effective immediately, market-makers who submit prices for the PBOC’s reference rate will have to consider the previous day’s closing spot rate, foreign-exchange demand and supply, as well as changes in major currency rates, the central bank said in a statement..

China’s hand may have been forced as the recent strengthening of the yuan caused exports to slow. The yuan saw a huge run-up in the fourth quarter of 2014. After giving up some of those gains earlier this year, the Chinese currency continued a constant rise as the yuan’s value has been closely tied to the value of the now skyrocketing U.S. dollar. This new move by China may be to stem the huge run-up and more closely value the Chinese money to it’s non-U.S. trading partners.

source: tradingeconomics.com

While slowing the growth of the yuan will help Chinese manufacturers, it could also lead to capital flight as investors seek stronger currencies like the U.S. dollar.

Some see a currency war on the horizon.

As other currencies seek to maintain their export figures, they will likely cut the value of the currencies as well.

“It’s hard to believe this will be a one-off adjustment,” said Stephen Roach, a former non-executive chairman for Morgan Stanley in Asia. “The race to the bottom just became a good deal more treacherous.”