China Devalues - The Trilemma Bites Both China and Japan

The announcement today of a sharp devaluation of the Rmb is a capitulation to strategic necessity which a) had already been quietly seen on the OANDA fx site since July 31st, though not, curiously on Bloomberg and b) was the inevitable outcome of the failure of the Xi Jingping Put.

To repeat: 
"The logic of the situation is that the damage inflicted on the financial system will force a clarity of policy which finally over-rides the deep desire to ignore the monetary policy trilemma.  In short, monetary policy can become truly expansionary, in which case there is a sacrifice to be made either of the short-term stability of the Rmb, or the phased dismantling of capital controls and other structures of financial repression.  The alternative is that the damage to the financial system is unrelieved by monetary policy, but policies to open the capital account and sustain the stability of the Rmb are maintained. Almost certainly that will now entail a hard landing. 

"In short, the choices have suddenly got both hard and urgent."

There are immediate consequences to think about.

For China,  there are two fundamental questions:
1. The Communist Party has discovered that it cannot control the market.  Given the unrivalled importance that maintaining control has in the Party's list of priorities, what does that mean for the future of the market in China?
2. The Chinese people have discovered that the Party cannot control the market. What does that mean for the economic choices to be made by China's households and companies?

For the rest of Asia, there is one very obvious question: what happens now to Japanese policy. Those of you who subscribe to my  Shocks & Surprises Global Weekly Summary will have read on its front page this week:

"In Asia, Bank of Japan’s monetary policy board meeting produced no new initiatives, but commentary from the bank’s governor which bordered on the complacent. In fact, Japan’s momentum indicators for domestic demand and the industrial sector are now flagging in a way not seen since the election of PM Abe. If one of the outcomes of China’s stockmarket collapse is a depreciation of the Rmb, Bank of Japan could yet discover new vulnerabilities in the Japanese economy."

To be plain, about 71% of Northeast Asia's exports come from China, and given the weakness of Western demand,  a 1.9% devaluation in the Rmb will quickly result in a 1.9% fall in the dollar price of China's export prices, which will inexorably be followed by matching falls elsewhere in Asia's export prices. Any Asian country which has been relying on devaluing its way back to competitiveness with China will feel the pressure. So there's more policy initiatives to come - and not leas from the Bank of Japan.