China's Participation in Currency War a Double-Edged Sword

With the dollar having risen 3.5 percent against the yuan since January 2014, China has entered the currency war.

And that's a mixed big for the world's second largest economy. While the yuan's slide greases China's export machine by making its goods cheaper in foreign currency terms, it also pushes global investors away from the country.

From 2005 until early 2014, China allowed a gradual appreciation of the yuan, amid strong prodding from the United States. But for now anyway, it has abandoned that policy.

That's bad news for Chinese companies and banks that have borrowed an estimated $1 trillion of debt in dollars over the past five years, expecting the yuan's ascent to continue, The New York Times reports.

Yuan depreciation would make their debt less expensive, but the yuan's drop makes it more expensive.

"They [China's central bank] cannot afford to let it [the yuan] depreciate too quickly," Liu Li-gang, a China economist at ANZ bank, told The Times. "Firms could be pushed into default."

The dollar stood at 6.2562 yuan Sunday.

China is poised to intensify its involvement in the global currency conflict, many experts say.

"The economic backdrop, with a race to the bottom, tells me that the [yuan] is likely to experience weakness in the years ahead," Russell Thompson, chief investment officer at Cambridge Strategy hedge fund, tells The Wall Street Journal. China is "caught in a debt trap."

China's slowing economic growth will push the government to depress the currency, foreign exchange market participants say. Chinese GDP rose 7.4 percent last year, the slowest rate in 24 years.

To be sure, a small group of economists say there really is no global currency battle.

"The currency war story makes good copy and finds supporters, but it lacks any consistent set of facts to back it up," First Trust Economists, led by Brian Wesbury, write in a commentary.

Monetary policy supposedly sparked the war, but the global economy isn't all about central banks, the economists explain.

"Some analysts think that central bank policy (specifically, quantitative easing) is the only thing that matters," the trio says. "They overlook innovation, investment, and just plain old hard work and argue that stock prices, interest rates and economic performance are driven by central bank stimulus."

Related Stories:

• Strategist Lieberman: There Is No Currency War
• Experts: China Ready to Join Currency Battle in Earnest
  
• BofA: Currency War Has Broken Out