Fri Jul 29th, 2005 at 09:56:07 AM EST
This diary was originally posted on Daily Kos yesterday, and I've reposted it here today at Jerome's request. Some of the more lecture-y bits about China and American attitudes toward it probably don't apply on this blog. I've updated the yuan to the July 29 fixing.
Yes, I know the yuan was revalued a week ago, but a lot of the discussion at the time was poorly informed so I thought I should post a quick diary explaining what happened and why the change in China was at least potentially important economically.
There's been a lot of China bashing on this blog, as there has been in U.S. political discourse generally. A lot of this has been spectacularly ill-informed, or based on conventional wisdom that's distorted or over-simplified or outdated, or what have you. China's government is certainly open to criticism, but ignorant criticism is ineffective.
First off. What happened last Thursday was that China in fact abandoned the yuan's 10-year-old peg at 8.28 to the dollar, replacing it with a tie to a basket of currencies. This had the immediate effect of revaluing the yuan by 2.1 percent to 8.11 to the dollar.
For some on Kos, this was all they knew and all they needed to know -- the revaluation was token, it won't help the trade balance and who knows when the Chinese will revalue again. However, the devil is in the details, and the devil in this case is poking the argument with its pitchfork. What actually happened is a lot more interesting, and potentially important.
Under the current system, China's State Administration of Foreign Exchange (often called by the acronym SAFE) fixes the yuan every afternoon based on the basket of currencies, the contents of which haven't been disclosed (It will take smart currency traders a couple of months to figure it out.) The yuan then trades in a range of 0.3 percent to the peg for the following 24 hours. Under the current system, China can gradually allow the yuan to gain value at a pace that allows its exporters to adjust.
This is much more flexible than the previous system, where the yuan was fixed at 8.28 to the dollar, period, and was allowed only to trade in a narrow range within that figure. In fact the new system is flexible enough that JPMorgan Chase & Co. is predicting that the yuan will appreciate 15 percent against the dollar by the end of 2006. This is probably a fairly aggressive estimate -- I'd be surprised if it were more than 8-10 percent at most. There's already been a tiny bit of further revaluation, today's (July 29) fixing of the yuan was at 8.1056 to the dollar -- not an inconsiderable daily move in the currency markets where fortunes are made and lost on that third decimal place.
But, wait! I hear you say. Didn't the Chinese government say don't expect much more in the way of revaluation any time soon? Well, yes, it did say that. But nobody in the markets believed it. The reason is that everybody assumed that China was just trying to discourage a surge of "hot" money into China seeking to gain from further revaluation. (If you own yuan or yuan-denominated assets and the value of the yuan rises you make a profit purely off of the foreign exchange gain.)
China's dead scared of hot money because the sudden outflow of hot money was one of the causes of the Asian financial crisis. China pretty much escaped that debacle, in part because its currency wasn't then tradeable, and so couldn't be attacked (Macau also escaped because there's no international market in the pataca. I had images of currency speculators going around with shopping bags to banks to build up a position, but none of them were that dedicated.) Now the yuan IS directly traded (there's also a market in what are called non-deliverable forwards), and is freely convertible on what's called the current account, so there is some vulnerability there.
There's going to be a lot of internal debate in China's government about how much revaluation to allow and at what pace. The trade ministry is already saying that a revaluation of any more than 5 percent will damage exports, etc., etc. China is no longer the cheapest place in the world to make things (wages are lower in Vietnam, Indonesia, Bangladesh and I believe Cambodia of countries that actually do export manufacturing), and there's a sense in the government that China shouldn't be competing purely on price to make the cheapest stuff any more. That's why in the textile disputes with the U.S. and EU it agreed to put export tariffs on some the lower-end textiles. Revaluation is one way of forcing manufacturers to give up the lower-value (and lower value-added products), move up the value chain, think about productivity and mechanize. No country wants to be stuck at the bottom of the value chain forever.
China's government is also keen to promote consumption so that growth isn't too export-dependent. That's why, starting a few years ago, it started giving everyone long breaks around national day (Oct. 1) and labor day (May 1) in addition to the traditional two weeks off around Chinese New Year (set by the lunar calendar so floats, generally in January or February.) That way everyone had time off to go travel and shop.
I'm drifting off topic here. One last point: a gradual revaluation, if that's what we get, is better for the U.S. as well. A sudden jump would have been inflationary, driving up the price of toys, clothes and low-end consumer electronics. Plus, it would have suddenly devalued all those U.S. T-bills China holds. If China really doesn't revalue any further, or holds the revaluation at too low a level, then look for political pressure to start building again. And people who say this was purely a token move will be justified. They're not justified yet.
BTW, I live in Asia, and currencies are (tangentially) related to what I do for a living, so I have at least some idea of what I'm talking about.