China Devaluation Illustrates Zero Sum Game Nature Of Exchange Rate

So China has started to devalue its currency. What can be said about that?

The cause of this move is that the sharp gains of the U.S. dollar against almost all other currencies (the yuan being until recently one of the few exceptions) recently has in effect caused a large appreciation of the yuan too.

That was tolerable to Chinese leaders as long as the economy remained strong, but now it has started to weaken. And so Chinese leaders now feel compelled to in effect follow the path of the other two key Chinese trading partners, Japan and the euro area, and debase its currency. And indeed. just like the drop of the yen and the euro have raised inflation in those areas, China’s devaluation will raise its inflation rate, but probably not its real growth rate even though that’s what Chinese leaders hope.

Anyway, the point is that this move will have a deflationary impact on the rest of the world, including the other countries with central banks that are doing everything they can to raise its inflation rate, like Japan, the euro area-and Sweden.

This again illustrates that exchange rates is a zero sum game. When one country, or currency area, tries to achieve inflation by lowering its exchange rate, it will have a deflationary/disinflationary effect on the rest of the world


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