Business Insider reached out to Mohamed El-Erian for his take on the surprise Chinese currency move. Here is what he told us:
With markets again reacting today to the Chinese currency news, it is important not to lose sight of the economic bottom line: This week’s currency policy decision is the right structural step for the country over the medium-term (and eventually for the global economy); but, also important and more immediate for financial markets, it is occurring at the wrong cyclical time for a world that is struggling mightily to generate sufficient high-quality growth.
As part of its efforts to navigate its tricky “middle income” development transition, China is taking an important step towards a more determined market-based system for exchange rate determination.
It is a step that others have been urging for a while (thus the generally supportive comments out of the International Monetary Fund and the US Treasury). And it is one that, over time, would serve longer-term global economic stability, including more-timely rebalancing.
The problem for financial markets is the specific timing of the move: One that makes sense for China, but not for the rest of the world.
Recent economic data out of China point to an economy that continues to weaken, with the country’s international trade also under pressure. As such, if its action is not countered by subsequent currency weaknesses in other countries, the Chinese economy stands to benefit from the devaluation associated with the choice of timing for the move towards the more market-determined exchange rate system. But, given remaining structural constraints within China, this gain is likely to come at the expense of other countries.
In basic economic terms, the substitution effect is likely to dominate any positive income effect.
Reacting to this this, markets are pricing outcomes that involve: a higher possibility over the short-run for weaker global growth, greater volatility, and renewed currency weakness in the emerging world.
Moreover, the risks of market overshoots cannot be dismissed lightly, particularly given the inherent instability of EM currencies and the extent to which risk markets in general have been supported by central bank actions.
In a perfect world, China would have moved towards a market-determined currency regime against the backdrop of robust Chinese and global growth. But this is not the case.
As such, the challenge for policymakers is to maintain an option on the longer-term benefits of China’s policy move while managing the short-term instability. Thus the rather curious occurrence of the PBoC, China’s central bank, intervening to limit a devaluation that it has itself induced through its policy decision.
And it’s a phenomenon that is not limited to China. Other countries need to consider the implications, including the US Federal Reserve which now has a new factor to consider as it prepares for its important September FOMC policy meeting.
Mohamed A. El-Erian is the former CEO/co-CIO of PIMCO. He is Chief Economic Advisor at Allianz and member of its International Executive Committee, Chair of President Obama’s Global Development Council and author of the NYT/WSJ bestseller “When Markets Collide.”