China should float the renminbi

The big news of the day is that the Chinese authorities have allowed the renminbi to depreciate by 2%. This has triggered the normal sensationalist warnings about an upcoming “currency war”.

I must say I find these warnings to be rather uneducated about monetary theory and about monetary history. Hence, normally it is said that devaluations have the purpose of improving “competitiveness” and that such policy is an act of beggar-thy-neighbor and that this kind of policies caused a protectionist spiral during the Great Depression.

However, this is not in fact correct. First, of all if a country needs to ease monetary policy to stabilise nominal spending then it follows logically that the currency of the country will have to depreciate. That, however, need not be the purpose, but rather a side-effect of monetary easing. Rather it is normally so that if we look at historical examples of large devaluations – for example the US in 1933 or Argentina in 2001-2 then the primary effect of the monetary easing is a sharp recovery in domestic demand, which actually tends to benefit exports from neighboring countries rather than hurt them.

Furthermore, during the 1930s it was not the countries, which gave up the gold standard and devalued, which introduced protectionist measures. Rather it was the countries, which refused to give up the gold standard, which instead increased tariffs and other protectionist measures.

Furthermore, we are in a situation of still relatively meager global growth and deflationary tendencies around the world and in such a world monetary easing should be welcomed rather than criticized as it will help spur global growth.

Finally it is somewhat paradoxically that anybody would criticize a 2% devaluation, while not at the same time demand that commodity exporters like Russia, Brazil and Norway –  which have seen the currencies weaken substantially recently – should do something to prop up their currencies. Obviously these countries should not be criticized for allow their currencies to weaken in response to a negative shock to the economy, but neither should China. Today’s devaluation is not a hostile act – it is a attempt to stabilize Chinese aggregate demand and as such the policy should be welcomed.

Give up the fine-tuning and let the renminbi float

That being said I also think that today’s devaluation is rather foolish – simply because I want more and not less. In my view the right policy would be for China to swiftly move towards a free floating renminbi and a total liberalization of capital and currency flows and to introduce a policy to stabilize nominal demand (NGDP) growth in the Chinese economy.

Hence, every other large economy in the world – with the exception of those trapped in the euro – have floating exchange rates and in general the purpose of monetary policy in these countries is to provide nominal stability in some form. China should of course do the same thing. That would be to the great benefit of China and would once and for all stop the silly discussion about “competitive devaluations”.

Have I written about this before? You bet – just have a look here:

Bernanke knows why ‘currency war’ is good news – US lawmakers don’t

‘The Myth of Currency War’

Don’t tell me the ‘currency war’ is bad for European exports – the one graph version

The New York Times joins the ‘currency war worriers’ – that is a mistake

The exchange rate fallacy: Currency war or a race to save the global economy?

Is monetary easing (devaluation) a hostile act?

Fiscal devaluation – a terrible idea that will never work

Mises was clueless about the effects of devaluation

Exchange rates and monetary policy – it’s not about competitiveness: Some Argentine lessons

The luck of the ‘Scandies’


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  1. Peter A

     /  August 11, 2015

    Ball park – how much more should the market “depreciate” the RMB?

    • That is a very good question. In my view monetary policy at the moment is too tight so some further monetary easing certainly is warranted, but at the same time I am very uncertain about how much of this is due to too tight monetary policy and how much is due to structural weakness in the economy. Furthermore, I don’t think that we would be in for a “currency crisis”-size correction (50-80%) in the currency. So ball-park – very ball-park – I would say between 10 and 20%.

  2. Can u please explain logically why monetary easing and a large devaluation shall lead to a “sharp recovery of domestic demand”?

    According to economists like M. Pettis, a currency devaluation, is the same as a tariff for consumers, because prices go up.

  3. ” refused to give up the gold standard, which instead increased tariffs and other protectionist measures.”

    The countries that left the gold standard, benefited from export-driven growth thanks to the weak currency, but with the weak currency they imposed an implicit tariff for consumers.
    While the gold standard countries maintained their purchasing power.
    No wonder that they have to introduce tariffs to limit purchasing power again and prop up thier local producers.

  4. Coming back to China and its potential currency devaluation:
    According to Pettis, many Chinese consumers target a fixed saving sum per month. When interest rates go down, then the quantity saved must go up. This increases the savings rate.

    Depreciating the currency, however, does the complete opposite: It is a reduction of purchasing power and raises the savings rate.

  5. While I agree with the idea to float the Renmimbi, I still think it will not change a lot. As opposed to commodity countries, Chinese terms of trade are improving, hence the Renmimbi must appreciate.

    Moreover, one must consider the big difference between the “gross” Chinese trade surplus (surplus before investments) and the net trade surplus (after deduction imported capital goods).

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