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  • China's Not-So-New Currency Policy

    Yuan

    Beijing finally made a move on exchange rates, probably. Assuming there is some action to go with the People’s Bank of China’s stilted language, two critical errors are being made in the international response.

    The first concerns the nature of the change. The one-line summary, in China and elsewhere, is that the PRC has broken the peg of the yuan to the U.S. dollar. Or re-broken it, since the peg is said to have been broken in July 2005, then reestablished in July 2008.

    This view is badly mistaken. The yuan peg to the dollar was not ended in July 2005, it was simply loosened. There is no evidence in the yuan’s movement against other currencies that the peg was broken, or even dented.

    From mid-2005 to mid-2008, the yuan tracked the dollar against the euro, just as it always had. It tracked the dollar against the yen. The yuan did not fall as much as the dollar over this period because a tight peg was replaced by a “crawling peg,” where the yuan rose 20% against the dollar. The yuan was not, however, allowed to move independently of the dollar against any other currency.

    What little the People’s Bank has said suggests there will be even less of a shift now. The limits on daily movement in the yuan are unchanged. The announcement notes “further reform” – if there used to be a peg and now it’s broken, that isn’t “further” anything. Moreover, the present weakness of the euro will make the PRC even more reluctant than in 2005 to move off the dollar.

    Why does this matter? Because genuinely breaking the peg would be a boon for the global economy. Resuming the crawling peg is just a bone for the U.S. Congress, and one the Congress and everyone else could choke on.

    From mid-2005 to mid-2008, when the yuan-dollar peg was supposedly first broken, global imbalances worsened considerably. This helped trigger the current financial crisis. If that fraudulent de-pegging is repeated, the whole process may be repeated, including another global contraction.

    The Congress could again get what it thinks it wants: a double-digit revaluation of the yuan against the dollar, if a very slow one. But it would again not have the effect Congress wants – the Sino-American trade imbalance could widen, just as it did from 2005-2008.

    What the U.S. and the world need from China is not a rerun of false reform, but true progress toward an independent currency for the globe’s second-largest economy. That would strike a blow against imbalances, in particular slowing the accumulation of dollars in Beijing’s hands and encouraging Chinese consumption in the long term. But it would give the Chinese government one less tool to control its economy, so the peg will likely remain and change will be cosmetic.

    Posted in International [slideshow_deploy]

    One Response to China's Not-So-New Currency Policy

    1. AGreenInvestor says:

      China’s Central Bank has sought to defuse the huge pressure being built up on China to appreciate its currency.In a statement,the Bank it talks about “reforming the currency”.There is no hard numbers about appreciation or the timeline of the reforms.It would surprise me that China appreciated the currency too soon as its economy is already slowing down .http://bit.ly/dnpa7I

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