Currency traders around the globe lazily staring into their screens must have found themselves transfixed last Friday when the flatline indicating the value of the Chinese yuan (or renminbi if you prefer) suddenly jumped to life. And so it was that during a brief 20 minute interval the yuan surged to a level of 8.270 to the dollar from the hypnotic and seemingly eternal value of 8.276. Now 6 thousandths of a dollar isn’t really a very big deal, but it is the sheer fact that it happened that is causing all the fuss.
The official explanation offered was that there had been ‘technical problems’ (which were interpreted that some state minion somewhere or other accidentally pushed the wrong button: not altogether impossible), but the fact that this ‘blip’ occured on the same day that a state-run newspaper – The China Securities Journal – ran an front page article that seemed to depart from previous government statements has been widely interpred as meaning that the ‘blip’ was more than a blip.
The article asserted that China had completed all the technical preparations necessary to remove the US dollar peg and allow greater flexibility in currency movements (presumeably these are not the same technical preparations that allowed the wrong button to be pushed 🙂 ). This article if taken in conjunction with recent statements from Zhou Xiaochuan, China’s central bank governor, who suggested last week that China might accelerate its timetable for a more flexible rate in response to growing international pressure, *might* indicate that some move was in the offing. Certainly Asian currency markets have interpreted things this way: the ‘glitch’ has been viewed as a dry run for a forthcoming ‘float’. Again it is interesting to note that – according to the Financial Times – currency traders could not say whether the State Administration for Foreign Exchange, the government agency that handles currency trades, conducted any business at the higher rate. This is important since one of the things the ‘experiment’ might have been intended to test – if experiment it was – would be the sensitivity of the market price to currency intervention from the above named body.
At this point it is impossible to say when China will move to make its currency more flexible, but it does seem probable that the day will not be too long in coming. The really important and interesting question is what consequences this change will have.
This question needs examining since in my view too many people are placing an exaggerated emphasis on this change as a solution to some of the major ‘ills’ which the global economy is currency facing. In particular this issue has often been raised in the context of the US current account deficit, and more recently in the context of what is being increasingly perceived as the EU ‘textiles crisis’.
In order to get things in perspective it is important to keep in mind three basic and obvious facts: China is huge, China is poor, and China is currently undergoing a process of rapid economic development.
The first of these facts is fundamental. It is this that makes all the difference between what is happening in China (and of course also India) today, and what happened in the so-called ‘Asian Tigers’ (S. Korea, Singapore, Taiwan, Hong Kong) twenty years ago. China is so big that any change in China is inevitably going to cause a major backwash in the global economy. This is all too evident in the case of the current surge in oil and other raw material prices. Even a small change in China can have a significant global impact.
So I think it is important first to situate what is happening in the context of a more general phenomenon of what are called ‘global imbalances’. Since these imbalances have been accumulating over decades now, it is clear that any rapid unwinding is not going to be an easy matter.
Now for the currency question. It is hard to foresee how far the Chinese currency will float up when the change happens. As I indicated in the introduction, any float is likely to be a controlled float. What does this mean? Well it is highly likely that the above-mentioned State Administration for Foreign Exchange will intervene in the currency markets to control the rate of increase. Not only is this likely, it is also desireable. As is often repeated China is still not a market economy. It is making important steps in the direction of becoming one, but there is still a long, long way to go.
In terms of the non-market characteristics of the Chinese financial system Bloomberg’s Andy Mukherjee had an interesting recent article: Greenspan Misses the Point About the Yuan which is well worth reading as background.
In particular I think it is important to stress the evolutionary approach to China’s financial arrangements since the consequence of introducing change too rapidly would be to destabilse China and (given the point about China being huge) through China destabilise other parts of the global economy. I repeat the global imbalances are important and they cannot be resolved at the stroke of a pen. One of the consequences of these global imbalances at the present time is that growth in the global economy is unduly dependent on growth in China, so we need to remember this.
Now going back to any revaluation, in the short term China’s currency might rise say 5%. What would be the consequence of this? Well I think in the end price of Chinese products here in Europe or in the US the effect would be negligable. You only need to look at the origin costs of manufactured products in China, and the end price in our shops to see that there are huge mark-ups along the line. A small rise in the currency could be easily absorbed imho. If you look at the fact that the euro has risen something like 45% in the last two to three years, while export prices (in dollars) for German manufactures have risen to nothing like this extent then you can begin to get some idea of what will in all probability happen.
We could also remember that the arguments used by the ‘anti-China’ lobby have gone through three phases so far. In the first place it was suggested that China’s growth figures were not real. Then the argument moved on, and China was suggested to be riddled with financial black holes. Now the problem is perceived to be an undervalued currency. The interesting thing is that all of these points are in some measure true: we cannot place the same confidence on official figures in China as we do on, say, the US government figures, the Chinese banking sector *does* have a significant problem with non-performing loans, and yes, China’s currency is undoubtedly undervalued. The key question is to encourage China to put in place measures to resolve these issues over time, and also to bear in mind that progress on none of these issues is going to have an immediate and dramatic impact on our trading relations with China in the here and now.