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OK. So China devalued its currency today.

How exactly does that happen?

Does some official tell the Foreign Exchange the the new exchange rate for the yuan is 0.98 * the current exchange rate?

Does it just print more?

What is the process by which a government actually devalues its currency?

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Does some official tell the Foreign Exchange the the new exchange rate for the yuan is 0.98 * the current exchange rate?

For China (and other countries with fixed/controlled exchange rates) - that's exactly how it happens.

Does it just print more?

This is the way to go for fully convertible currencies (like the USD, EUR, GBP, and handful of others, there're about 20 in the world). Flood the market and as with any commodity - flooding the market leads to a price drop.

Obviously "just print more" is much harder to do than picking up the phone and saying "Now you're buying/selling dollars at this price and if you don't I'll have you executed".

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Currencies that are pegged or fixed require that foreign currencies are held by the central issuer at a proportional amount. This is analogous to having a portfolio of currencies that the central bank issues shares from - in the form of its own currency.

We will continue with this analogy, if the central bank says these "shares" are worth $1, but the underlying components of the portfolio are worth $0.80 and decreasing, then it is expensive for the central bank to maintain its peg, and eventually they will have to disregard the peg as people start questioning the central bank's solvency. (People will know the $1 they hold is not really worth what the central bank says it is, because of the price changes people experience in buying goods and services, especially when it comes to imports. Shadow economies will also trade using a currency more reflective of labor, which happens no matter what the government's punishments are for doing so).

Swiss National Bank (central bank) did this in early 2015, as it experienced volatility in the Euro which it had previously been trying to keep it's currency pegged to. It became too expensive for it to keep this peg on its own.

The central bank can devalue its currency by adjusting the proportions of the reserve, such as selling a lot of foreign currency X, buying more of currency Y. They can and do take losses doing this. (Swiss National Bank is maintaining a large loss)

They can also flood their economy with more of their currency, diluting the value of each individual 1 dollar equivalent. This is done by issuing bonds or monetizing goods and services from the private sector in exchange for bonds. People colloquially call this "printing money" but it is a misnomer in this day and age where printers are not relevant tools. The good and service goes onto the central bank's balance book, and the company/entity that provided the service now has a bond on its book which can be immediately sold to someone else for cash (another reading is that the bond is as good as cash). The bond didn't previously exist until the central bank said it did, and central banks can infinitely exchange goods and services for bonds.

Bond monetization (also called Quantitative Easing) is practiced by the Federal Reserve in the United States, Bank of Japan, European Central Bank and now the Central Bank of the Republic of China

  • CHF was never pegged to EUR, don't know where you got the idea. The rise of CHF early this year was largely because of the volatility of EUR and people moving money from EUR to CHF. The Central Bank of Switzerland does not control the exchange rate, at least not in the way Chinese Central Bank does. They can only sell or buy EUR to affect the market, but its the market that controls the CHF rate. Chinese currency exchange rate, on the other hand is set, and their QE is not relevant in this context. – littleadv Aug 11 '15 at 20:57
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    @littleadv the rise of the CHF was precisely BECAUSE the SNB ceased manipulation of their currency. They've been doing it since 2011. snb.ch/en/mmr/reference/pre_20150115/source/pre_20150115.en.pdf This isn't mutually exclusive of market forces, said forces were what caused the bank to abandon the peg because it no longer represented the market and would have become more and more expensive to maintain. Never said this is the same as what China is doing. It is worth nothing that China is also not immune to market forces, and their various "one time adjustments" are responses – CQM Aug 11 '15 at 21:02
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    manipulations - yes, peg - no. There was no peg. They tried to affect the market and keep the rate lower, but as the EUR volatility grew it required more and more resources, and one day they decided to give up. But there was no "peg". – littleadv Aug 11 '15 at 21:07
  • @littleadv how exactly do you define that? It was colloquially called a peg in finance circles, as much as QE is colloquially called printing money – CQM Aug 11 '15 at 21:09
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    peg is what happened when EUR was introduced and all the original currencies were pegged to it and got frozen in value wrt to EUR. This is not what was the situation with CHF. It is freely convertible and has been for quite some time. – littleadv Aug 11 '15 at 21:28

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