London, UK (BBN)-THERE have been some dramatic devaluations in history—think of sterling in 1967 and 1992, or Argentina in 2001/2.
When currencies decline, they do so in a big way.
China's devaluation of the yuan on Tuesday is less than 2 per cent, but it is also being treated as a major story, reports The Economist.
Robert Peston of the BBC says it is more significant than either the Greek crisis or if the Federal Reserve raised interest rates.
The combination of falling commodity prices and weaker emerging markets is certainly a worry.
Bears have predicted that a Chinese devaluation would send a new wave of deflation* round the globe.
It would force Asian competitors to respond with their own devaluations, reducing import prices in the developed world.
This might lead to job losses in the west or reduced profit margins. Charles Dumas of Lombard Street Research, a consultancy, recently wrote that it:
But a 2 per cent devaluation is neither here nor there.
It will hardly be a massive boost to Chinese exports, which fell 8.3 per cent in July.
The Bank for International Settlements calculates real trade-weighted indices for different currencies; as of June, China's index was 126, up from 111 a year earlier and 105 in September 2012.
This shift is just a marginal retracement of that gain.
So this move looks more like a signal than anything else. In particular, it may be a response to IMF concerns about whether to grant the yuan reserve currency status and inclusion in the special drawing right (SDR) basket.
China would very much like to get that status, partly for prestige reasons and partly to help its financial sector.
So a little bit of currency flexibility might help, yet the move is not big enough to really annoy the country's Asian neighbours or the Americans.
But can China manage the process effectively? A limited devaluation may encourage traders to expect more, whether the People's Bank of China (PBoC) says so or not.
And that will require the PBoC to use reserves to defend the new rate.
It has lots of reserves, of course, but still the recent $300 billion reduction might give the authorities pause.
China is trying to juggle several balls at once; to move from an investment-led economy to a consumption-led model without letting growth slip too far, to rein in speculation in property and equities without damaging industry, to engage with markets without being hit by volatility, and to expand its financial sector without suffering the hot money flows that destabilised Asia in the late 1990s.
It would be surprising if it didn't drop at least one ball. And its task is so complicated that it is bound to send out confusing signals every now and then.
* The counter-argument is that currency wars are good news as they are usually accompanied by monetary easing.
Even if all currencies end up where they started (not everyone can devalue, of course), the world will have easier monetary policy as a result.
The big question here is whether monetary policy has lost its effectiveness and the only positive result from quantitative easing and other policies is the currency impact.
In that case, it is a zero-sum game.
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