To hijack a John F. Kennedy quote, China let a small, peaceful revolution happen in its currency to avoid a violent one.
Or, as one Chinese central bank official put it: “a fixed exchange rate looks stable but it hides accumulated problems.”
The People’s Bank of China allowed a devaluation on Tuesday, rather than forcing one.
The country let market forces in, just a little bit, to release the downward pressure on the yuan, in the hope it could eventually stimulate its flagging economy.
And it did this by changing the methodology of how it calculates its fix. The central bank said it would let market forces have more influence over the reference for the currency fix, taking into account the previous day’s price, and flows in foreign exchange supply and demand.
The currency has stabilised a bit today after soothing messages from the central bank but here’s what happened to the yuan this week:
Of course, China was not averse to using its reserves and legal powers to intervene in the market to get the fix it wanted. While the government has spent billions propping up the falling stock market, foreign exchange traders also suspected the Chinese state bought and sold yen towards the end of the trading day to get the price fix it wanted.
It underlines the complex relationship Communist China has with the free market, and a very gradual move towards a more open policy.
The tension is summed up in a great quote from PBoC Assistant Governor Zhang Xiaohui in a press conference: “Trust the market, fear the market, respect the market and follow the market.”
That’s a shift from a statement from Chinese financial regulators in 2014, who told investors to “invest rationally, respect the market, fear the market.”
No trusting or following the market back then.