Why did China crash the yuan?

Three ways China's currency plunge affects your money
Three ways China's currency plunge affects your money

Why did Beijing decide to let the yuan depreciate?

That question has vexed economists and investors alike in recent days, setting off a desperate search for clues in the scant communications emanating from the People's Bank of China.

Two theories have emerged: It was, some say, a landmark reform that will allow market forces more influence over China's currency; others argue it was a naked domestic stimulus measure that invites a currency war in Asia.

Beijing insists its motives are pure.

The central bank says its decision to change the way the yuan's value is set every day -- a calculation that now uses the previous day's closing price instead of the bank's own opaque process -- is a market-oriented reform. It's something that has long been requested by the international community.

The reform "will continue to be pushed forward with a market orientation," the bank said Tuesday. Market forces will now "play a bigger role" in determining exchange rates, it added.

The International Monetary Fund, which has been considering the yuan for inclusion in its elite group of currencies, praised the move. In a statement that largely echoed Beijing's explanation, the IMF said the decision "should allow market forces to have a greater role."

Related: China's yuan devaluation turns up heat on Asia

Some analysts see another motive: China's economy is struggling, and a weaker yuan would make the country's exports more attractive to international buyers. Devaluing the currency would be one way to quickly inject some life back into the country's factories.

China's most recent export data was abysmal, and the startling results "clearly pushed the PBOC to use one of its most powerful instruments to reboot the Chinese economy: the exchange rate," wrote economists at Natixis.

If this was indeed the central bank's motivation, and the "market forces" rationale was just a cover, China has risked setting off a series of tit-for-tat responses from its neighbors in the region, an event sometimes referred to as a currency war.

"In today's world, where almost everyone is aspiring to export-led growth, a deliberate attempt to lower the currency is indeed currency warfare," wrote analysts at Oxford Economics. "China is not alone in this ... but by engaging in administrative depreciation, China risks setting off the wider currency wars that have so far been avoided."

On Thursday, after the yuan had fallen by more than 3% in just three trading sessions, central bank officials called an exceedingly rare press conference, and sought to explain their reasoning.

The officials largely stuck to their guns, saying they were motivated be a desire to implement market-oriented reforms, and arguing that circumstances do not warrant continued depreciation. Investors responded favorably, giving the yuan a boost.

The bank also addressed its naysayers, with officials acknowledging they had expected the yuan to decline. But, they said, a 3% fall was enough to bring the currency to a reasonable level, and the one-time depreciation was "largely finished."

"Today's PBOC press conference supports our view that the fall in the [yuan] as a result of the shift to a new reference rate mechanism was a one-off and not an attempt to engineer a large scale competitive depreciation," analysts at Capital Economics wrote.

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