beyondbrics

You say appreciation. I say flexibility.

Last weekend’s widely-praised announcement by China’s central bank that it would no longer peg the renminbi to the US dollar is already attracting a backlash. Paul Krugman, a longtime critic of China’s currency policy, labelled the change “the renminbi runaround.”

Krugman has a point – the clearest evidence of the Rmb’s undervaluation is Beijing’s $2,400bn pile of foreign reserves, the product of systematic intervention in foreign exchange markets over the past decade.

Far from being a sign of strength, the size of the reserves are exhibit one for the case that China has mishandled its currency policy over a lengthy period. When it first moved to allow the currency to rise in mid-2005, it was years too late. The last few years, during which the currency was re pegged in mid-2008 as the global financial crisis set in, have only exacerbated the problem. The foreign reserves have continued to pile up, stashing even more money offshore in low-return US bonds that arguably belong to the underpaid
Chinese people themselves.

But if you look at the broader context of the economy, you can have more sympathy for Chinese policymakers, or least some of them.

To be sure, the Commerce Ministry and the old-style economic planners in the National Development and Reform Commission have opposed currency reform for all the wrong reasons, the former apparently to protect exporters’ profits, even if a majority of them accrue to foreign-invested companies, and the latter because they like to manage the market whenever possible.

But back to the appreciation vs. flexibility issue, and this week’s small movements in the currency, both up and down. While foreigners have focused solely on the need for China’s currency to rise, the modernisers in China have always stressed flexibility, with good reason. Tactically, it gives them room to move against their opponents in the system, who have been able to portray pressure for a stronger currency as a foreign plot. They are loath to broadcast to speculators that moving money into China is a one-way bet. They also want, quite sensibly, Chinese businesses to get used to a currency that moves both ways.

Finally, the currency is always going to be managed as long as China retains capital controls, which have served China well through the financial convulsions that have wrecked havoc in Asia and more recently in the west since the late nineties.

Sadly, a lot of China’s good intentions have been buried by the domestic political system, which takes years to reach a consensus on large policy changes. Delaying change has inevitably simply created a new set of excuses not to move.

In recent months, the Rmb has depreciated by about 17 per cent against the Euro. About 20 per cent of China’s trade is with Europe. By standing still, flexibility has now become a weapon for the naysayers as well. Of course, the currency should go up and down, the Commerce Ministry now argues, because of the Euro’s weakness. How convenient, even though most of China’s trade is still written in dollars!

As my colleague Geoff Dyer observed this morning, China’s latest move has won it some time, but the underlying issue has not gone away.

Related reading:
China’s currency plans remain unclear,FT