What is behind global financial markets’ extreme moves since China’s decision to allow its currency to move to a managed float? One explanation is that investors increasingly fear that global disinflation is not a dragon that has been slain by muscular central bank measures, but a phoenix that is rising from the ashes.
Certainly the direct impact of the renminbi fall on US and European inflation and economic activity — even if it extends to 10 per cent — is too small to justify the large falls in bond yields and inflation gauges. The renminbi’s weight in the trade-weighted dollar and euro is about 20 per cent and, as a rule of thumb, a 10 per cent rise in the trade-weighted dollar and euro takes about 0.5-0.6 per cent off inflation and real GDP growth over 18 months. So even if the renminbi is devalued by 10 per cent, the effect would be to cut US and European inflation and growth by only
10 or 20 basis points over a year, other things being equal.