About the Chinese currency reform
So yesterday it finally happened:-the yuan was revalued , after years of pressure from particularly the U.S. government but also the EU and Japan. However the move was much smaller than expected, a mere 2.1%. This will hardly satisfy Senators Smoot Schumer and Hawley Graham (as Larry Kudlow likes to call them).
Contrary to what some people seem to think, this currency reform will not mean that the yuan will float. China will continue to peg its currency, only now to a basket of currencies whose composition will be kept a secret, rather than to the dollar alone. This is the system Singapore has had for years and Malaysia also announced yesterday that they will switch their peg from the dollar alone to a basket of currencies. Surprisingly Hong Kong, the third Asian country whose currency were formally linked to the dollar [through a currency board], announced that they will keep the link to the dollar even though this will in effect mean that they will [albeit only to a lesser extent as the yuans movements against the dollar is likely to be small]sever the indirect link to the yuan. Normally fixed exchange rates are with the currency of the largest trading partner, and China are a much bigger trading partner than the U.S. for Hong Kong.
Ironically, this new system could mean that the yuan could again weaken against the dollar, if the recent rally of the dollar versus the euro and the yen continues and the yuan could perhaps fall below the old 8.28 exchange rate.
What will then the effects of this reform be?
A larger increase in the value of the yuan would have resulted in a higher U.S. consumer price inflation both because of the rise in prices of Chinese import goods and because of the rising commodity prices that a stronger yuan would have resulted in ( A stronger yuan means that dollar-denominated commodities will be cheaper for the Chinese, increasing their demand). Moreover, the likely reduction in the U.S. trade deficit would have translated into a lower capital inflow into America which in turn would have pushed up interest rates.
These effects would have been reinforced by the likely rise in the value of other Asian currencies that would have likely followed as many other Asian central bankers would have felt more relaxed about letting their currencies appreciate if the yuan rises in value too.
But a 2.1% exchange rate rise will have virtually no effect on the trade deficit and bond yields and consumer price inflation will hardly be affected at all either.
And because the yuan is pegged to a basket of currencies, exchange rate movements against the dollar will likely be small.
And while this move has in the short-term mildened criticism of China from western politicians, if it turns out that the final effect is a mere 2% appreciation or less, the Schumer-Graham tariff bill will likely be revived again.
So unless this move is followed up by another revaluation of a larger magnitude, this move will for all practical purposes only be a symbolic move, probably intended to postpone western protectionist measures.
Comments (14)
"mildened"? ;-)
But thanks for that clarification.
Published: July 22, 2005 12:31 PM
Hi Stefan: I strongly agree with your conclusion that this change is a “symbolic move�, although, I’m trying to understand it better at the same time.
If this basket of currency concept means that “China will continue to peg its currency� to the USD, but that it will also be pegged “to a basket of currencies … rather than to the dollar alone�, then I presume that the Yuan/USD peg will be and will remain at 8.11. Now is this peg, in respect to the USD some kind of floating peg, or is it the classical peg that we are used to from China (previously at 8.277)? I’m thinking that it’s the latter.
If I’m correct (maybe I’m not) then is it really true that Hong Kong’s keeping the link to the dollar will “sever the indirect link to the yuan�? My reasoning is that if the Yuan is now fixed at 8.11 to the dollar, and Hong Kong remains fixed to the dollar, then Hong Kong is still fixed to the Yuan, but at a new rate. Thanks!
Published: July 22, 2005 1:14 PM
Paul, you seem to have misunderstood what I wrote. The yuan is not going to continue to be pegged to the US dollar. Instead it will be pegged to a basket of currencies.
If you peg your currency to a currency basket this means that it will not be pegged to any particular currency but to a weighted average of a selected number of currencies. If we assumed for simplicity that the currency basket that the yuan is pegged to is weighted 50% dollar and 50% euro this means that if the dollar rises 10% against the euro this means that the yuan will rise 5% against the euro and fall 5% against the dollar.
And with this hypothetical weighting the Hong Kong dollar who will now be the only Asian currency strictly pegged to the dollar would also rise 5% against the yuan (and 10% against the euro).
Published: July 22, 2005 3:00 PM
I think I’m following you now.
I guess currencies change relative to the USD on a day-to-day basis. Do you expect the ratio between the yuan and dollar to fluctuate from day-to-day as well? Do you have any speculation on why the Chinese have not disclosed what currencies are in the basket or what the weighting will be? I wonder what the odds are that the basket formula is such that the USD is weighted .99, and all others summed up form the other .1. I guess time will tell.
Published: July 22, 2005 5:56 PM
Paul, it is difficult to answer these questions at this early point. As to why they don't want to tell the relative weighting is uncertain. It could either be a symbolic act of defiance or it could imply that they have near 100% weighting of the U.S. dollar [and Hong Kong dollar who is still pegged to the USD] which would make this whole reform a pure hoax apart from the marginal 2.1% revaluation.
If the U.S. dollar's weight is less than 90% or so then we should see daily fluctuations in the USD/yuan exchange rate as a function of the often significant fluctuations in the dollar exchange rate versus the yen and the euro and other currencies likely to be included in such a basket.
During the first trading day however the exchange rate has been very near the 8.11 mark, so judging by the behaviour of the People's bank of China so far. It remains to be seen during the coming days and weeks how this will work out in practice. If the fluctuations in the USD/yuan exchange rate is neglible then it would seem that the [US and HK]dollar weighting is near 100%, in which case the significance of the reform is really no greater than the marginal 2.1% upward revision.
Published: July 23, 2005 3:45 PM
I agree! I know i'll be watching it. This will be fun, because i am predicting it will remain fixed at 8.11 and this will be good for a laugh! If i'm wrong it will also be educational. It’s fun to watch and make predictions regarding history in the making.
Published: July 23, 2005 11:27 PM
Hi! I'm a student in China! And my major is Economics. I think the following point of your artical, "China will continue to peg its currency, only now to a basket of currencies whose composition will be kept a secret", is exactly what my government wanted to do!
Published: July 25, 2005 7:33 AM
Hey Stefan! Third day in a row: USDCNY=X holding steady at 8.11. I think you were are on to something when you said "...it could imply that they have near 100% weighting of the U.S. dollar ... which would make this whole reform a pure hoax apart from the marginal 2.1% revaluation."
Maybe three days is not enough time to be sure, but i noticed that the other currencies out there are not holding steady over this same period. Ha! Cool hoax.
http://finance.yahoo.com/q/bc?s=USDCNY=X&t=5d&l=on&z=m&q=l&c=USDAUD=X
Published: July 26, 2005 12:38 PM
It looks like the yuan is not changing much. This basket of currencies is weighted just right so that the various fluctuations all cancel themselves out to keep the yuan seemingly fixed in respect to the dollar. How amazing is that?
http://finance.yahoo.com/q/bc?s=USDCNY=X&t=5d&l=on&z=m&q=l&c=USDAUD=X
Published: August 5, 2005 5:08 PM
Interesting, Paul. Remember that during this time there has been a significant fall in the dollar's exchange rate against the euro, so it would appear that the dollar weighting is near 100%.
Published: August 6, 2005 3:47 PM
Now China has revealed which currencies are included: the US dollar, the euro, the yen and the South Korean won are "dominating" it, with the UK pound, the Russian rouble and the Thai baht also being included.
This would imply that the US dollar weighting is significantly less than 100% perhaps even lower than 50%. Which would surprise me given the fact that the yuan has traded in a narrow 8.10-8.11 range against the dollar even while the dollar has lost 3% against the euro. But admittedly I haven't followed the othr currencies movements against the dollar that well so it is possible that they have counteracted the increase in the value of the euro.
Published: August 10, 2005 4:27 PM
Too bad they don't give the formula. Here's what i think it is: 1USD = 8.11CNY.
I think this is funny, from the link you gave:
"...effectively strengthening it by 2.1% to 8.11 to the dollar.
"Since then, the yuan has appreciated slightly on China's restricted foreign exchange market, closing at 8.1062 to the dollar Wednesday."
When they use the word "slightly" they don't kid around.
I have looked at some other currencies including the Japanese yen and i would say that for the yuan to remain as steady as it has using anything other than a direct peg to the US dollar would be nothing short of a miracle. And when it comes to central banking, i don't believe in miracles.
Published: August 10, 2005 5:07 PM
This revaluation will be negative for the United States, but the negative impact of this revaluation of the Yuan vis-à -vis the dollar will be almost negligible. The revaluation will be beneficial for China for several reasons. First, the flexible exchange rate will help to protect it from macroeconomic volatility. Second, it will allow China to cool the over lending that has occurred with its new ability to raise interest rates. Before the revaluation, there was a fear that large capital inflows would result from higher interest rates. Chinese authorities are not against a gradual revaluation, but they want to make sure that the revaluation happens slowly (such as the recent 2.1% revaluation). China’s financial market is weak and it needs time to become better equipped to handle the large capital outflows that are expected to occur after a complete capital market liberalization.
Published: February 20, 2006 9:39 PM
China's economics are most complex and dynamic - full of contradictions, inefficiencies and inconsistencies. Within the scheme of macro-economic management (if there is such a thing in China), the "currency issue" is a most "minor" issue. The world needs China as a "world factory" as much as China needs the world market for its manufactured goods. Herein lies the dilemma and "hypocracy" of the "West" for any rapid revaluation of China's currency will correspond to direct inflationary pressure of the West. In higher-valued manufactured goods, manufacturers in China are capable of costing down up to 50% of that of the US/EU. As China's manufacturing (and exports) continue to climb up the value chain, China will revalue stepwise. But such will not solve the problem of the West.
Anyone interested may browse my weblog http://chinastreeteconomist.squarespace.com - for some fun and unconventional economics of China.
Published: August 2, 2006 4:46 AM