RMB

Today, for the first time, the midpoint set by Safe exceeded the 0.5 per cent tolerance bands set around the original exchange rate of 6.8275 – by half a basis point.

Not as historic as many expected at the start of the week. But then ‘flexibility’ does not mean ‘strength’: a flexible exchange rate can go up or down. Geoff Dyer, the FT’s China bureau chief, points out that domestic and international takes on the new policy differ greatly – principally because their desires differ greatly. Internationally, a stronger yuan is wanted. Domestically, the “export lobby is welcoming [flexibility] as a way of protecting itself from a weaker euro.”

China’s new policy has not completely ruled out the prospects of a political showdown. The obvious flashpoint is if the euro does weaken substantially again.

 

One of the big risks for the Chinese authorities in beginning to gently appreciate the currency is that they set up a one-way bet for investors who believe that the renminbi can only get stronger from now on. Large inflows of hot money could make it difficult to conduct monetary policy, officials fear, and might potentially aggravate inflation.

That explains why there has been much more talk since Saturday about volatility in renminbi trading and using a currency basket as a reference. When China abandoned its currency peg in 2005, it said the renminbi would trade against a currency basket of its main trading partners, but in reality it trailed the US dollar and was much less volatile than the 0.5 per cent daily trading bands allowed.

“In one area, the emphasis will be different this time,” says Li Daokui, a central bank advisor who believes the authorities will pay more attention now to the basket in which the euro plays a large role. Economists who have been briefed by the central bank say that there will also be more daily volatility, in order to keep speculators on their toes.

This means that in principle, says Mr Li, that if the euro gets much weaker, the renminbi could fall against the dollar. Richard Yetsenga at HSBC says something similar: 

Forward prices for the renminbi are surging even though there is no exchange rate shift yet from the People’s Bank of China, which announced on Saturday it would “enhance flexibility” of the exchange rate. In a defensive statement lacking detail, the Bank said it would:

“further enable market to play a fundamental role in resource allocation, promote a more balanced BOP account, maintain the RMB exchange rate basically stable at an adaptive and equilibrium level, and achieve the macroeconomic and financial stability in China.”

But two things suggest this change will not prove as significant as it could be. First, the language. The statement talks of ‘furthering’ and ‘enhancing’ the current policy, rather than changing it. The only change word, ‘reform’, is used to refer to a continuing process.

Second, the defensive tone and text. “The basis for 

China’s central bank has spoken of measuring the yuan “with reference to a currency basket”. One of the bank’s academic advisers, Xia Bin, said the change in language suggests a change to the dollar peg, reports Business Week. An economist at Morgan Stanley interpreted the shift in the wording of the report as significant, and yuan forward prices have been rising for the past two days on speculation of a rise in the currency.

Reining in property speculation is not enough to combat inflation. An advisor to the Chinese central bank has said there is a fundamental problem with the PBoC mandate.

Zhou Qiren said there was “conflict” between the bank’s forex intervention and its job to manage liquidity and control inflation, reports Bloomberg. Speaking of the record levels of lending in 2009, he said: “Unless there are very forceful measures, that large amount of money will flow through the market. Even if you put lid on in one place, it will emerge somewhere else.” 

Growing evidence suggests a stronger yuan would not help the US economy nearly as much as thought, if at all. Even increased Chinese consumption is shown not to help much. So why do these assumptions continue to underpin politicians’ rhetoric?

First, the evidence:

  1. Yuan revaluation could cut global growth by 1.5 per cent (April 26)
  2. Chinese saving less and spending more would have very little impact on US jobs (April 25)
  3. A 15 per cent appreciation of the RMB would reduce the American trade deficit by 5 per cent by the end of next year, but would be short-lived and would not flow through to GDP (April 16);
  4. “Chinese revaluation is in the interests of China, not the US” (April 16)
  5. “People seem to ascribe a ridiculously outsized role to China’s currency policy in producing China’s trade surplus and America’s trade deficit. The level of rhetoric is simply not consistent with the impact of the peg.” (March 15)

Even large changes in Chinese currency or consumption have little effect on the other side of the Pacific: US-China trade is simply too small to transmit much of the effect, so the arguments run.

So, second, why the continued assumption 

From Reuters:-

China’s foreign exchange regulator is considering cutting short-term foreign debt quotas for some commercial banks, three sources familiar with the situation said on Friday, as it seeks to curb speculation over yuan appreciation. 

“Chinese revaluation is not in the US interest.” This is one of the major conclusions from a collection of short essays on the Sino-US currency dispute (eBook). Other conclusions are that a revaluation is in China’s interest, and that the size of the RMB undervaluation is between 2.5 and 27.5 per cent.

The conclusions back up research performed by PwC for Money Supply on Friday. They found that while a renminbi appreciation would reduce the US trade deficit, the effects would not flow through to GDP and would, at any rate, be short-lived.

A 15 per cent appreciation of the renminbi would reduce the American trade deficit by just 5 per cent by the end of next year, and the effects would not significantly increase GDP. 

Alan Beattie

The latest of a stream of paper out of the IMF in the run-up to its meetings next week came out today: the analytical chapters (as opposed to the forecast) of the world economic outlook. Personally I’ve always thought they were more interesting than the forecast, since no-one is that good at macroeconomic forecasting and the Fund doesn’t have access to much more information than anyone else.

Anyway, this one is on economies that have exited from large current account surpluses and how they did it. Short of calling the chapter Memo To Beijing, it could scarcely be less explicit. No big surprise that they recommend an appreciating exchange rate.