Of course, some of this decline simply reflected a convergence between the official rate and the actual market rate. Although it is inherently difficult to say what share of transactions already were taking place at the market rate, some estimates put the share as high as 80%, in which case the effective devaluation was only about 10%. However, since the market rate itself depreciated about 40% during the previous two years, the fact that some transactions were already occurring at the market rate may not be that important. It only reduces the suddeness of the devaluation.
Another reason to be cautious about the effective magnitude of the Chinese devaluation is that during this period China's inflation rate exceeded the U.S. inflation rate, so that some of the devaluation simply reflected a higher overall rate of price increase in China. Again, it is hard to say how important this consideration is, since China's consumer price data are notoriously difficult to interpret. On the face of it, China's 26% rate of inflation during 1994 would seem to offset much of the nominal devaluation. However, most experts agree that China's official inflation rate greatly overstates the actual inflation rate, particularly in the tradeable goods sector. Moreover, the same kind of inflation-induced real appreciation was taking place in most ASEAN nations, albeit to a lesser degree.
Despite these caveats concerning the magnitude of the effective devaluation by China, evidence suggests that it had a real impact on China's export competitiveness. For example, China's aggregate trade balance went from a deficit of $10.6 billion in 1993 to a surplus of $4.2 billion in 1994. At the same time, trade balances rapidly deteriorated in Thailand, Malaysia, and Indonesia. Only in the Philippines did the trade balance remain relatively stable.
Clearly, China's devaluation represented a severe negative shock to the economies of Southeast Asia. The question now is to understand how this kind of shock alters the incentives of central banks to support their exchange rates. We argue that this loss of competitiveness gave central banks in the region an incentive to devalue, that currency speculators knew this, and that this reassessment of the costs and benefits of devaluation precipitated an attack on these countries' currencies.
