The UK knows only too well what it means to have an overvalued currency - sterling’s strength has dulled the competitiveness of the UK’s export-oriented manufacturing industry for decades.
Even though the UK earns around 30 per cent of its GDP from exports, the continuously large trade deficit on goods means that overall trade is a persistent drag on economic growth.
For manufacturers, the UK is a sub-optimal currency zone. Factories are mainly located in the less well off regional economies and their competitiveness is harmed by the ‘London effect’ that pushes up sterling.
The UK has a floating currency and is priced by market forces. Costly interventions to make it more competitive would be unsustainable. This means UK manufacturers need to find other ways to become more competitive. However, the same isn’t true for Chinese export-oriented manufacturers.
For decades, China has been an engine of global growth and trade. But that engine has been gradually slowing, as rising labour costs and keeping the yuan pegged to the dollar for too long have eroded China’s competitive edge.
Last August, worries that China could be heading for a hard landing came to the fore with a messy stock market sell-off and a devaluation of the yuan. A second devaluation and market sell-off this year has reignited those same fears.
The failure of China’s communist leaders to communicate with markets is bound to create uncertainty and make financial markets apprehensive. But getting the yuan back in line with China’s economic fundamentals is a positive and necessary step and will bolster its economy and exports.
The other option, an internal devaluation through falling wages is undesirable and would undermine the long-term goal of rebalancing toward a consumer and services-led economy.
Less than five per cent of the UK’s exports go to China, so sterling-yuan moves aren’t really a big concern for the UK, even if it tips the trade balance even further in China’s favour.
But an undesirably fast slowdown of China’s economy would be a real worry. It would have far reaching repercussions for global growth, and a large open economy like the UK would surely suffer.
So, moving to an appropriately priced yuan that boosts China’s growth should be viewed positively from the UK’s perspective. The fact that the PBoC is currently spending hard earned foreign FX reserves to prop up the yuan means that unlike the UK’s problem with sterling, the good news is for China, it won’t have to fight against market forces to bring the yuan down a peg.