With the US Federal Reserve’s first rate rise approaching, China’s decision to allow the renminbi to depreciate bears similarities to the Swiss National Bank’s pre-emptive reaction to European quantitative easing in January. The lessons from other discarded currency pegs loom large. Asia and Latin America in the 1990s taught us that currency pegs reinforced and indeed exacerbated financial cycles. Asset prices tended to overshoot on the upside, creating macro imbalances that were eventually corrected through catastrophic devaluations.

There are both parallels and differences in China’s case. The similarities are that the renminbi experienced a near decade-long appreciation against the dollar and most of its trading partner currencies. The trend was characterised by low volatility and high predictability. Incentives to speculate were large. Foreign capital, often disguised as trade or direct investment flows, circumvented capital controls to enter the real estate market. And after 2008 Chinese groups began to borrow aggressively abroad.

Unless the currency peg is dissolved at a point in the cycle when balance-of-payments flows are reasonably balanced, a de-peg tends to release any volatility that has been stored up, and the currency tends to overshoot in the direction against which the central bank has been leaning. In the Chinese case, as with Asia in the 1990s, the direction has become clearly weaker.