China’s Going All Bendy On Us

Robert Flint at Wall Street Journal:

With a brief announcement Saturday of more flexibility for the yuan, China sent a powerful message about its confidence in the health of the world’s economy and financial system.

The resumption of the yuan’s crawling peg to a basket of currencies, with a daily fluctuation range of 0.5% on either side of a central parity rate, in no way implies a large one-off revaluation of the yuan.

In fact, the People’s Bank of China doused any such expectations by stating, “the basis for large-scale appreciation of the RMB exchange rate does not exist. “Instead, the PBOC will “maintain the RMB exchange rate basically stable at an adaptive and equilibrium level, and achieve the macroeconomic and financial stability in China.”

Basically, the PBOC has decided the recovery inside and outside China has reached the point that an appreciating yuan won’t put the country at a disadvantage. That’s been China’s stance since 1994. The goal has always been more flexibility for the yuan, with the ultimate goal of hard currency status at some unspecified point in the future.

The statement released Saturday says nothing about the pace of yuan appreciation. Using history as a guide, the yuan gained about 21% in the three years following the abandonment of the defacto peg to the dollar on July 21, 2005.

Derek Scissors at Heritage Foundation:

Beijing finally made a move on exchange rates, probably. Assuming there is some action to go with the People’s Bank of China’s stilted language, two critical errors are being made in the international response.

The first concerns the nature of the change. The one-line summary, in China and elsewhere, is that the PRC has broken the peg of the yuan to the U.S. dollar. Or re-broken it, since the peg is said to have been broken in July 2005, then reestablished in July 2008.

This view is badly mistaken. The yuan peg to the dollar was not ended in July 2005, it was simply loosened. There is no evidence in the yuan’s movement against other currencies that the peg was broken, or even dented.

From mid-2005 to mid-2008, the yuan tracked the dollar against the euro, just as it always had. It tracked the dollar against the yen. The yuan did not fall as much as the dollar over this period because a tight peg was replaced by a “crawling peg,” where the yuan rose 20% against the dollar. The yuan was not, however, allowed to move independently of the dollar against any other currency.

What little the People’s Bank has said suggests there will be even less of a shift now. The limits on daily movement in the yuan are unchanged. The announcement notes “further reform” – if there used to be a peg and now it’s broken, that isn’t “further” anything. Moreover, the present weakness of the euro will make the PRC even more reluctant than in 2005 to move off the dollar.

Why does this matter? Because genuinely breaking the peg would be a boon for the global economy. Resuming the crawling peg is just a bone for the U.S. Congress, and one the Congress and everyone else could choke on.

The Economist:

The statement was “vague and limited”, according to Charles Schumer, a Democratic senator from New York who is sponsoring a bill to slap duties on Chinese imports. It was followed by another statement on June 20th (in Chinese only) reassuring everyone that basic stability would be safeguarded.

The PBOC was clearer about what it intends not to do. It pointed out that China’s controversial current-account surplus has narrowed over recent years, from 11% of GDP in 2007 to 6.1% of GDP last year. There was therefore no justification for a “large-scale appreciation” of the exchange rate, it said. Most likely, the central bank will first allow the yuan to wobble by up to 0.5% each day. When it is confident that China’s economic momentum can survive the euro-area’s woes, it will let the yuan strengthen at about the same pace as before the crisis, ie about 5% a year, on a trade-weighted, inflation-adjusted basis.

The PBOC said it will be guided by a “basket” of currencies, not the dollar alone. If the euro resumes its slide in the next few weeks or months, the yuan might even be nudged down a bit against the dollar, to keep its trade-weighted value stable. America’s Congressmen, don’t much care for nice debates about the equilibrium, trade-weighted value of a currency. They do care about how many yuan you can buy for a dollar. Tao Wang of UBS has ventured an answer to that question. She forecasts that by the end of 2011, you will be able to get 6.2 yuan for the dollar, compared with 6.83 now.

That in itself is not a momentous change. But it is best to see this weekend’s move as an institutional reform, rather than a change in price. It was a slow, deliberate step towards a more sophisticated currency regime, rather than a stronger currency per se. As China’s economy evolves over the next few years, weaning itself off investment spending and towards consumption, it now has a suppler exchange rate that can help guide and cushion that process. Presumably that is what the PBOC meant by an “adaptive” currency.

Colin Barr at Fortune:

Geithner has been calling for the Chinese to liberalize their exchange rate policies since before he took over as Treasury secretary. He has been under pressure from U.S.  legislators who contend China has been holding down the renminbi, unfairly subsidizing its export sector. They say a free-floating renminbi would rise sharply against the dollar, raising the prices of Chinese goods and bringing manufacturing jobs back to this side of the Pacific.

Saturday’s move is only a tentative first step. Still, it is clear that the move toward a free-trading renminbi, begun in 2005 and interrupted by the near collapse of the global financial system three years later, has resumed. Geithner applauded the move, which comes ahead of next weekend’s G20 summit in Toronto.

“We welcome China’s decision to increase the flexibility of its exchange rate. Vigorous implementation would make a positive contribution to strong and balanced global growth,” Geithner said. “We look forward to continuing our work with China in the G20 and bilaterally to strengthen the recovery.”

Yet the future course of the exchange rate, and of a tightrope-walking global economic recovery, is hardly clear.

Matthew Yglesias:

There’s been a long running dispute about whether it will be necessary for the United States to formally threaten sanctions on China unless they revalue their currency. The answer now seems to be “no” as China is conceding the need to allow for more flexibility on exchange rates. The precise details are somewhat unclear, and the Chinese are cautioning the world not to expect rapid appreciation, so there will doubtless continue to be conflicts around this.

One thing I note here is that RMB appreciation is in part a form of tighter monetary policy in China. Which is good, China needs tighter monetary policy. And so do India and Brazil, all of which are likewise tightening. But no country is an island. Tightening in the three largest developing countries is the correct policy, but it makes looser policy in the U.S., E.U., and Japan all the more urgent. Likewise, fiscal contraction does seem to be the right policy for some European states (though not for Germany) but this again enhances the need for looser monetary policy from the European Central Bank.

Alex Frangos and Jason Dean in WSJ:

.In a lot of ways, this weekend’s timing is similar to what happened in 2005, the first time China loosened its currency, says Mirae Asset Securities Chief Economist Bill Belchere. “In 2005, they surprised the market. The market was waiting, waiting, waiting, got bored and then left,” he said. This time, the market was long the yuan for months before concerns about property market bubbles and euro zone troubles pushed risk takers out of the trade.

Now that the cat is out of the bag, don’t expect China to let the yuan strengthen right away, says Maguire. “In the immediate period, you’ll see very little move. They aren’t going to signal the flood gates are open, and then here goes the yuan. There will be a period of time before a significant move,” he says.


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Filed under China, Economics, The Crisis

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