The 2020 Mid-Year Economic Update_long

What Happens in China Doesn’t Stay in China

Devaluation of the Chinese yuan likely to have global impact.
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China is no Las Vegas. What happens there doesn't stay there – at least according to several sources over the past week. The country's devaluation of its currency, the yuan, may have ripple effects throughout the global economy.

For one, the devaluation reduces the price of Chinese exports, which can give them an edge over competitors. As we noted last week, the U.S. trade deficit continued to swell in the first half of the year – a "deeply troubling" trend according to Ernest Preeg, senior adviser for international trade and finance at the Manufacturers Alliance for Productivity and Innovation. Chinese exports in the first half were $532 billion – or 41 percent larger than the $376 billion of U.S. exports, according to MAPI analysis – and were in surplus by $166 billion compared with a $160 billion U.S. deficit.

The decline also has the potential to delay the anticipated interest rate hike from the Federal Reserve. Federal Reserve Board Chair Janet Yellen has said the hike will happen, but the timing is dependent on international developments. According to David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institute, speaking on NPR's Morning Edition, the Fed may indeed decide to hold off on the move if the devaluation is deemed to be a symptom of a slowing global economy.

This is good news for U.S. consumers, as the pressure will likely keep commodity prices lower, translating to lower prices at the pump and in stores.

By most measures, the overall depreciation was modest – 4.4 percent as of last Thursday – but at the same time it's the largest depreciation in 20 years, which could be a signal of a shift in how China is managing its currency. It may be that China is trying to "improve the credibility of its currency," Wessel said, in the hopes of "getting the blessing of the International Monetary Fund" as a benchmark currency. To do that, the IMF has previously said that China would have to loosen control of monetary policy.

Right now, the ripples are just beginning, and it's too early to say with any certainty how far they will reach. Future actions – by China, the U.S. and other countries – will also affect the overall impact of the move.

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