China’s currency, the RMB (人民币) dropped by a cumulative 4.4% against the U.S. dollar during the week of Aug 10., which was the biggest one day drop of RMB in the past 20 years. The drop drew the world’s attention for several reasons: China’s exports have suddenly become cheaper and imports into China more expensive, the RMB has a major influence on other Asian currencies, and the drop is another important event in the war of exchange rates between the PBOC and the Federal Reserve. Financial institutions and economists have released numerous macro and microeconomic reports on this sudden devaluation. For instance, Goldman Sachs emphasized that the drop worsened the global economic condition and adds pressure to the commodity market. This article will approach the sudden devaluation from various aspects, trying to give the reader a brief yet informative analysis of the impacts and purposes of the PBOC’s sudden devaluation of RMB. The IMF (International Monetary Fund) announced that the RMB would not be added into its benchmark currency basket, and one of the main reasons for this is that the Chinese central government and PBOC have been controlling the currency exchange rate. The RMB exchange rate should be decided by the market in lieu of the government. PBOC realized a simple yet effective move should be executed: marketize the RMB exchange rate and prove that the RMB is able to withstand the test of the free market. The result was quite obvious; the Chinese won.In fact, the devaluation of the RMB has had the same effect as the revaluation of the USD or increased interest rates in the U.S. In this regard, the devaluation of the RMB actually slightly raised the interest rates in the U.S. in early August, which was supposed to be done by the Federal Reserve in September. The raised interest rates had an immense negative impact on the global stock markets. The Nasdaq, S&P 500-stock index, and the Dow Jones were at their peak, and would be majorly negatively influenced with a continuous impact. However, the Chinese market has already experienced the crash of the stock market. Nevertheless, it is neither tightly correlated with the currency exchange rate nor the real economy, which means its volatile stock does not reflect the real economic situation, and this difference means that the majority of the global stock market would be significantly influenced. It is obvious that during the previous round of capital globalization, China attracted a large amount of capital abroad. Furthermore, the devaluation of Asian currencies resulting from this sudden devaluation of RMB has lead global equities to lose at least $5 trillion, and has the possibility of causing more shocks and volatility of the global stock markets, including China, the U.S., and Europe.Moreover, with the devaluation of the RMB the oil price dropped dramatically, and it eventually took over the USD and became the denominating currency for oil trading. In this regard, the currency war between China and the U.S. has entered an important round. Aside from the oil market, there are many other purposes for this sudden devaluation of RMB. Despite the fact that RMB revaluation in the past ten years stimulates imports, it has also caused a huge amount of the book loss from exports, which was hundreds of billions of dollars. The sudden devaluation could help the government and the PBOC “retrieve” these book losses. Moreover, a lower RMB exchange rate could stop capital from leaving China because the cost of transferring huge amounts of capital would be extremely high. This action not only benefits the foreign investments in the local Chinese market, but it also prevents international players from balefully shorting the Chinese stock market. Furthermore, it can push up the USD, which not only benefits other economies, but also attracts more foreign investments in China, which benefits China’s economic development in the mid to long-run.Author’s comment: This piece of analysis is neither a completed paper nor does it cover all possible causes and results of the devaluation of the RMB. I hope it provides some information about the issue and spurs you to think about currency rate shock and stock volatility. This article was written by Johnson Hantao Huang. Send an email to [email protected] to get in touch. Photo Credit: Arshaun Darabnia