The 2% devaluation of the Chinese yuan on Monday, and subsequent 1.6% weakening on Tuesday, was variously described as surprising and stunning. I think it was to be expected, given China's slowing growth, although there was no particular reason to believe Monday would be the day. In evaluating the effects, one has to first place the drop in context.

The devaluation against the dollar was quite marked, as shown in Figure 1.

Figure 1: US dollars per Chinese yuan, average per month (blue), and value for 8/12 (blue square). NBER defined recession dates shaded gray. Dashed line at Lehman (2008M09). Source: federal reserve Board via FRED.

However, it's important to recall that the dollar has had a rapid ascent over the past year, so that the real trade weighted value of the yuan has also been rising. This is shown in Figure 2.

Figure 2: Log broad value of real trade weighted Chinese yuan, 2010=0 (blue) and value for 2015M08 assuming 2% depreciation relative to 2015M06. NBER defined recession dates shaded gray. Dashed line at Lehman (2008M09). Source: BIS and author's calculations.

Already, there is talk of “currency wars”. From Washington Post:

Stephen Roach, a fellow at Yale University who formerly served as a non-executive chairman for Morgan Stanley in Asia, told Bloomberg that the move raised the “possibility of a new and increasingly destabilizing skirmish in the ever-widening global currency war.”

There is no doubt that this move will tend to further appreciate the dollar. China accounts for 21.3% of the weight in the Fed's broad currency basket dollar index.[1] But as shown in Chinn (2015), several East Asian currencies already quasi-peg to the yuan, so that a weight of about 1/3 is probably more relevant. Figure 3 depicts the implied appreciation of the dollar's value against a broad basket assuming all other bilateral weights experience zero change, and East Asian currencies move one for one with the yuan.