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China unpegs

July 22nd, 2005

China has announced a small revaluation of the renminbi yuan against the dollar, and a move to a managed float, relative to a basket of currencies (apparently this will be like the Australian system of the 1970s, a ‘crawling peg’, with the rate announced on a daily basis). Brad Setser has analysis and links.

I would have thought a revaluation of at least 10 per cent would have been a better idea, giving speculators at least some reason to think the next move might be down, but decisions like this are highly political.

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  1. Andrew Reynolds
    July 22nd, 2005 at 12:29 | #1

    And so the game continues.
    Being the conservative government they are they will wait and see – my best guess is that the currency will come under attack, tentative at first but increasing, the Bank of China will close back up, The US will protest, The Bank of China will move again – slowly. The cycle will repeat, with the Bank of China getting more confident each time.

    Bit of a game, but the hedge funds will love it. Good on ‘em.

  2. still working it out
    July 22nd, 2005 at 12:37 | #2

    Oh my God. I didn’t think they’d really do it. Interesting times ahead.

  3. e sciaroni
    July 22nd, 2005 at 13:20 | #3

    I don’t see how the RMB can be sucessfully attacked considering China’s war chest full of American Treasury bills. The fact that they will peg to other currencies will allow the US dollar to fall further.

  4. Katz
    July 22nd, 2005 at 13:40 | #4

    Presumably, the almost universal expectation is that the RMB will continue to appreciate against other major currencies, especially the US$.

    This is quite the opposite to (say) the predicament that the UK found itself in during the 1990s when Nigel Lawson dumped a cool $14b or so attempting to maintain an unsustainably high exchange rate for sterling by using foreign reserves to buy Sterling.

    If the Central Bank of China wanted to use a market mechanism to restrain the rise of RMB, presumably they’d sell RMBs, not use foreign reserves buy RMBs. And one method of doing that would be to continue to buy US Treasury paper.

    If, on the other hand, Chinese authorities decided that they might allow a cleaner float, then the temptation to buy US Treasury paper might be reduced. This may have interesting effects for US government finances, including the need to raise interest rates.

  5. still working it out
    July 22nd, 2005 at 15:01 | #5

    They won’t be trying to attack the RMB. They want to make money from its rise. China does not want the RMB to rise too much but the speculator’s may be able to force it up faster than China wants by buying up lots of RMB. To counter this China will have to buy even more US treasuries (or Unocal’s) not sell treasuries . Its current stock of US treasury bills won’t help it keep its currency down.

  6. Razor
    July 22nd, 2005 at 16:44 | #6

    Weak bastards – should have gone straight to a free float. They will eventually be forced too. It just depends on how much they are prepared to bugger up their economy before taking the plunge.

  7. Mr_A
    July 22nd, 2005 at 18:10 | #7

    Lets not forget the key concern about domestic inflation, which is estimated to be around 6-7% p.a. Roubini has an older, but good commentary http://www.roubiniglobal.com/archives/2005/03/china_will_they.html. Good luck trying to dampen that with a 2% p.a change.

    I love this quote from the above mentioned Brad Setser & co:

    “incremental reform is the wrong strategy in the currency domain, where the initial disequilibrium is so large and where controlling expectations of future exchange rate changes is essential to internal and external balance”

    This is another beautiful attempt at using equlibrium thinking to justify policy where it is blatantly obvious that the authors have in mind an impact that is mainly psychological rather than economic. Since its modern birth, when was China ever in equilibrium? Obviously, speculators care only about fundamentals in as much as they think it will affect relevant policy. But what on earth can be considered the correct balanced position in China’s case?

    How Do the pundits think this will influence the A$?

  8. Andrew Reynolds
    July 23rd, 2005 at 17:16 | #8

    It will be very positive for the $A – the Chinese will be able to buy even more of our primary products at cheaper (for them) prices.

    The RMB can be attacked – just not by selling short. If the expectation is that the RMB will rise (a not unreasonable expectation) the correct response would be to buy it (or assets denominated in it) and hold them. The USD and other foreign assets held by the BoC will then increase, helping bring forward (forcing) the next revaluation – allowing profit realisation. This cycle will repeat until the RMB reaches a realistic level. A dirty float, in effect.

    Watch the foreign reserves of the BoC increase over the next few weeks and months.

  9. Terje
    July 23rd, 2005 at 21:34 | #9

    Fixing the exchange rate is better than fixing the interest rate. However it does depend on what you fix the exchange rate to. If you fix it to something that represents a stable measure of value then its a great form of monetary policy.

    So the question for China is will a TWI of currencies be any better than the US dollar in terms of value stability. And will the loss of trade transparency with the USA be worth the change.

    In the old days we all used gold as the universal reference for value and we all fixed the value of our currency relative to that. Later on we all fixed to the US dollar, but that system fell apart once the US dollar was no longer fixed to gold.

    The Euro is managed with referenced to the HICP (Harmonized Index of Consumer Prices).

    So what is the most stable measure of value:-

    1. The US dollar.
    2. Indexes of domestic consumer prices.
    3. Grams of Gold.
    4. Indexes of foreign currencies.

    I take the view that most nations should fix their exchange rate with respect to gold. Certainly Australia should. And if China is not going to fix to the US dollar then they could do much worse than fixing the exchange rate to gold.

  10. I-D-A-log
    July 24th, 2005 at 16:11 | #10

    John,

    I am curious why you think 10%, or rather that there will be any significant change.

    Just to be trivial I checked a few prices and they fit with my experience when visiting China, keeping in mind that prices in China countryside are much, much cheaper than Shanghai for example.

    Big Mac index
    China USA Australia
    1.27 3.06 2.50

    Hilton Hotel – published rates
    Shanghai Boston Melbourne
    140 209 150

    All very interesting, but surely has nothing to do with why the Chinese authorities fixed the rate in the first place or why they may allow some small movement in the currency.

    I suspect that the rise in foreign reserves to almost $700b means that the Chinese authorities now enough money in the kitty to determine the exchange rate they want, while pretending to the satisfaction of the foolish ideologs in the west that by this managed float of the yuan they are moving inevitably to free and open economy.

    It is the height of foolishness for us to believe that a regime which has so ruthlessly put down any opposition has anything put self interest at heart.

    Rather than praying for the Chinese leadership to lose their minds and suddenly become advocates of the “free market”, we should take a reality pill and start acting in our own best interests.

    We need to curb destruction of what is left of our own economy and the environment in a more intelligent way.

    a small example: We will consider a label on a fridge showing how “energy efficient” it is but there are no such labels indicating the level of environmental damage it’s production caused nor an indication of how well treated/badly exploited the workers are.

    Why not?

    I think because we are too tied up in silly debates on the minutia of ideology, personality politics and fear of the extremists to actually think creatively or look after ourselves and those we purport to care about.

  11. Andrew Reynolds
    July 24th, 2005 at 16:42 | #11

    I-B-A log,

    What do you actually propose? Should we put more labels on everything and that will fix the China currency problem?
    To me, our own best interests would involve completely free trade and de-regulation to a great extent – but I think you probably mean something else is your first proposal is to regulate to put more labels on the things we buy.

  12. Terje
    July 24th, 2005 at 21:32 | #12

    QUOTE: To me, our own best interests would involve completely free trade and de-regulation to a great extent

    RESPONSE: I agree. However do you think that they would ever repeal the Australian laws of 1910 and allow private currency to once again circulate through the market.

  13. Andrew Reynolds
    July 25th, 2005 at 11:06 | #13

    Terje – off topic, but certainly worth looking at. I have been looking at this area for several years and I have not yet found a killer argument against it.
    Can’t see China doing it any time soon, though.

  14. Terje
    July 25th, 2005 at 16:25 | #14

    China did lift the prohibition on citizens owning gold bullion in 2002 after a 50 year ban. Something the Americans did in 1975.

    I suppose we are ahead in that our government never prohibited the private ownership of gold bullion.

    Last year (2004) our financial regulators did close down the few exchange merchants that were trading in e-gold. One of the few modern private currencies was banished from our shores.

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