Industries across the world are bracing for a deflationary shock as China devalues, but Beijing adamant there is no secret plan to drive down the yuan
[Reposted from The Telegraph | Ambrose Evans-Pritchard | August 13, 2015]
Chinese steelmakers are preparing to flood the global market with cut-price exports as they take advantage of this week’s shock devaluation of the yuan, setting off furious protests from struggling competitors in Europe and the US.
It is the first warning sign of a deflationary wave of cheap products from China after the central bank, the People's Bank of China (HKSE: 3988-OL.HK - news) , abandoned its exchange rate regime, letting the currency fall in the steepest three-day drop since the country emerged as an economic powerhouse. The yuan has fallen 3.3pc against the dollar, closing at 6.3989 on Thursday.
Steel mills in the Chinese industrial hub of Hebei have already begun to trim prices of rebar mesh-wires used for building by between roughly $5 and $10 to $295, citing the devaluation as a fresh chance to offload excess stocks of steel.
Europe’s steel lobby Eurofer warned that there would be “very real competitiveness impacts” for European steel firms, already battling for their lives with wafer-thin margins.
America’s United Steelworkers accused China of predatory practices."It is time for China to live by the rules or face the consequences," said the union's international president, Leo Gerard.
The US steel group Nucor called the devaluation the “latest attempt to support Chinese industry at the expense of producers in the rest of the world who have to earn their cost of capital to survive.”
Indian tyre-makers have issued their own warnings, fearing a fresh rush of cheap imports from China. They are already grappling with a 100pc surge in shipments over the last year as the recession in China’s car industry displaces excess supply.
The anger is a foretaste of what China may face if this week’s devaluation is the start of a concerted effort to gain market share in a depressed global economy. Yet it is far from clear whether Beijing really has such an intention.
The People's Bank of China insisted on Thursday that the drop in the yuan was a one-off effect as the country shifts to a more market-friendly exchange regime, essentially a managed float. It described the sudden drop as “irrational” and said reports of a plot to drive down the yuan by 10pc were “nonsense”.
China's steel output
China’s share of global steel output has rocketed from 10pc to 50pc over the last decade. It has installed capacity of 1.1bn tonnes a year that it cannot possibly absorb as the Chinese economy shifts away from heavy industry.
It now has 340m tonnes of excess capacity, which has driven down global steel prices by 40pc since early 2014. “This overcapacity alone is more than double the EU's steel demand, and China is now exporting record quantities to Europe as a result,” said Eurofer.
The European Commission said it is the monitoring situation closely. It imposed anti-dumping penalties on Chinese stainless steel in March following a 200pc jump in Chinese imports in 2014.
It opened a parallel probe of rebar imports in April, one of a long list of anti-dumping investigations cases ranging from Chinese solar panels to silicon, aluminium foil, molybdenum wires, and aspartame.
The PBOC said China’s economy is picking up after credit growth jumped to a 31-month high in July. It predicted that the currency is likely to strengthen rather than weaken over the medium-run, given the scale of China’s current account surplus a record $137bn in the second quarter.
The authorities are convinced that a fresh cycle of growth is now well under way after a slump earlier this year, when the housing market hit bottom and a badly-managed fiscal crunch caused large parts of the economy to seize up.
Capital Economics said the monetary base has been surging at a 20pc rate over the last three months, implying a jump in output three to six months later.
Budget spending contracted over the winter months but is now picking up again and will reach a 14pc growth rate in the second half under the government’s plans, stoked by $315bn of new bond issues by local authorities.
Markets were spooked by a fall in China’s industrial output growth to 6pc in July (year-on-year), concluding that the economy is in deeper trouble than so far admitted. But Chinese officials say the data is meaningless, and had nothing to do with the PBOC’s decision to float the yuan.
The bad figures were chiefly due to typhoons and flooding in the southeast, as well as statistical base effects. Production halved in the industrial stronghold of Zhejiang south of Shanghai as a million people were evacuated.
The PBOC said there was “no basis for a continued depreciation of the renminbi (yuan)” and reminded traders that the Chinese authorities have very deep pockets, a warning that it can and will deploy its $3.65 trillion reserves to stabilize the exchange rate.
The central bank is keen to decouple from the over-mighty dollar as the US Federal Reserve prepares to raise interest rates. It appears to be switching instead to trade-weighted target, linked to a basket of currencies. The dollar peg has compounded China’s problems, leaving it defenseless against Japan's devaluation strategy.
The eurozone is in an odd position complaining about China’s exchange rate. The euro has fallen by 20pc since April 2014, and at least part of this was engineered through quantitative easing.
Whatever the rights and wrongs of this saga, the Chinese authorities themselves know that a concerted effort to weaken their currency could set off serious capital flight.
The PBOC would then face of choice of letting companies with $1.2 trillion of foreign debt spiral into crisis, or intervene by running down foreign reserves, which would automatically tighten monetary policy and set off a credit crunch.
Whatever the temptations of a devaluation quick-fix, the authorities are likely to conclude that in the unique circumstances of China it is better to stick with the devil you know.