Insights & Advice


Chinese Currency Change is a big Yawn

Newspapers around the world heralded the news that China was easing their currency peg. Global markets soared overnight Sunday and into Monday on the announcement. At last, crowed the pundits, the Chinese had caved into pressure from its trading partners to drop the two-year old Chinese practice of pegging the value of the Chinese Yuan to the rise and fall of the U.S. dollar. Yet, three days later it is hard to see what all the fuss is about.

Initially, investors hoped that the switch from pegging the Chinese Yuan against a single currency, the greenback, to a basket of currencies would cause the Yuan to appreciate further thus marking the end of cheap exports from China. For years, nations large and small have been clamoring for the Chinese to stop using their currency to expand their own exports while undercutting the export abilities of its competitors.

At the same time, so the story goes, a stronger Yuan would provide, over time, a boost to the Chinese consumer’s spending power as imports became cheaper. Overall, in a few years this change in policy could be the force that would rebalance the global economy. That would be good news to us here in the United States since we’ve been struggling under both a domestic recession and a massive trade and capital imbalance with our trading partners and especially with China.

For those of us who have been following the fortunes of the Middle Kingdom for several decades, we greeted this recent Chinese decision with a bit more cynicism. China does not cave in to foreign pressure on items as important as their currency and haven’t since the days when Western gunboats patrolled the Yangtze.

I learned in several Chinese studies courses in college that China considers itself the center of the world. Even today, despite over 200 years of Western economic dominance, the Chinese have not lost that superior, inward-looking attitude. Therefore, I believe that dropping the peg against the dollar in exchange for a basket of currencies was purely a decision influenced by domestic Chinese affairs.

After all, all China actually did was exchange a dollar peg for a basket of currencies peg. The dollar peg has actually hurt the Chinese ability to export to Europe this year since the dollar gained against the euro while the Yuan gained a whopping 14%. In fact, the Chinese may actually gain back some of it’s exporting power they have lost in Europe by lifting the dollar peg.

You might ask exactly how much will the Chinese currency appreciate as a result of this action.
Well, that’s not clear. The People’s Bank of China announcement was pitifully short on details. I would call it ambiguous. The statement expressed both a desire for greater flexibility while at the same time maintaining a basically stable exchange rate. Cynics like me could interpret this statement to mean that all the Chinese want to do is ditch the dollar, now that it is strengthening after years of weakness, while at the same time keeping the Yuan as cheap as possible to facilitate exports.

From surveys Wall Street has generated since the weekend, it appears most economists believe the Yuan’s appreciation against the dollar may be no more than 1.9% this year, which is a far cry from initial estimates of 5% and even 10% appreciation.

I would be surprised if it is even that much, especially if the Euro continues to fall against the dollar; in which case, the Chinese currency could even depreciate further and regain some of its export edge in Europe. The announcement also allows China to face this weekend’s G20 meeting with its head held high and its finger pointed at the mess European nations have made of their own community.

As for the U.S., I’m sure the Obama Administration will claim success in its campaign to pressure the Chinese to do something about their currency, but it is a token victory at best. Both nations know that it would take a Yuan devaluation of 25-30% to put any kind of dent in their trade imbalance with the United States.

Posted in Macroeconomics, The Retired Advisor