Three Reasons for a Chinese Revaluation Now

Ahead of Obama’s visit to China, the markets have been abuzz with a statement from the People's Bank of China that it will consider “changes in international capital flows and the trends of major currencies”. This is a departure from the broken record mantra of keeping its currency “basically stable at a reasonable and balanced level”. These statements have created speculation that China is ready to either revalue the RMB upwards or allow it to float.

Analysts have said for years that China will start to move when it is ready. So why now?

I can think of several reasons that, put together, might have prompted this change in attitude, as evidenced by several headlines that have crossed my desk:

• China is preparing the ground for the RMB as a regional currency, which lowers the demand for the US Dollar as a medium of exchange for world trade (hat tip Ron Liebis). There is the news that HSBC is facilitating trade using the RMB as a medium of exchange.
  
• China wants to continue to inflate, at least in the short term. When you read through the rhetoric, China is to continue its loose monetary policy despite its high growth. Isn’t loose monetary policy under these conditions inflationary and would tend to devalue your own currency?
  
• Chinese culture is big on "face". Making this statement ahead of Obama's visit gives the president "face" and shows for US consumption that he is making progress with the Chinese on the currency issue. They are more or less ready to move in any case so making these statements now cost them nothing.

What is not a reason? Tim Geithner’s statement that “I believe deeply that it’s very important to the United States, to the economic health of the United States, that we maintain a strong dollar.”

Watch the wheels within the wheels of Chinese policy.

Comments

[Dave Wrixon:]

Yes, this face business is complicated. It seems very often to be a way of bolstering your opponents pride only to turn it into his weakness.

Nov 13 05:55 AM

[AxIt:]

Untill exports will take a big share of China's GDP , nothing will change in the monetary policy. When an acceptable share of the GDP will be driven by internal demand (so will be less exports reliant), the monetary policy will change. China is in the process of stimulating internal demand, so this will happen. But not tomorrow.

Nov 13 06:53 AM

[Nikola:]

This is what HSBC is helping facilitate: www.hsbc.com.cn/1/2/co...

However, notice the many "No"s. This is not going to happen overnight.. The problem is once this is set in motion.... it's never going back to USD. Ever.

Chinese ALWAYS make statements before important meetings with Americans on these currency issues. They don't do it for face, they do it as a negotiating strategy. I am pretty sure that US politicians are used to it already. They make an eyebrow raising statement a few days before the meeting setting the stage. Then, usually, at the meeting itself, they strike an entirely different tone, leaving the other side unprepared. If Americans fall for this again, well....

Nov 13 09:11 AM

[MarkCaplan:]

"China wants to continue to inflate."

That makes the opposite argument you intended to make: Inflating the currency would tend to LOWER the value of the renminbi relative to the U.S. dollar. Much of the world is trying to persuade China to let the renminbi RISE against the dollar, which would tend to be deflationary for China.

Nov 13 01:58 PM

[Cam Hui:]

MarkCaplan: "China wants to continue to inflate."

That makes the opposite argument you intended to make: Inflating the currency would tend to LOWER the value of the renminbi relative to the U.S. dollar. Much of the world is trying to persuade China to let the renminbi RISE against the dollar, which would tend to be deflationary for China.

That's what I meant - it puts downward pressure on the RMB. That may be one reason why the Chinese want to do it now.

Nov 13 08:09 PM

[Ricard:]

"Chinese culture is big on "face". Making this statement ahead of Obama's visit gives the president "face" and shows for US consumption that he is making progress with the Chinese on the currency issue. They are more or less ready to move in any case so making these statements now cost them nothing."

I think you meant to say that US culture is big on "face". At least, that seems to be the implied argument in your statement. Of course, here we just call it 'pride' or 'patriotism'.

Nov 13 10:02 PM

[Steve20423:]

The problem with the Chinese Economy is real purchasing power of Chinese is low. So their economy will never be supported without exports. They are sitting on billions of cash but held by the very wealthy, the middle class has no real purchasing power. If they payed a fair wage the workers might find they have extra money to spend.

Nov 13 10:19 PM

[historymatters:]

China chose to keep its currency undervalued as a subsidy to exporters.I n the process accumulated such large reserves that a major revaluation of the RMB would be a big hit to its balance sheet. The country is already at a stage where a stronger currency should not be a problem, if anything they are late to the game. Reserves of the size China has are not a symptom of good policies but quite the opposite. They know it but will deal with it over time. I believe revaluations will be gradual unless US economic mismanagement hits new highs. But that this an unlikely scenario.Also bear in mind that China's huge surpluses are likely to be severely reduced as consumption grows.
Also I don't like arguments that invoke "face" or any other pseudo cultural explanation. There is hardly any economic culture more pragmatic than the Chinese. Westerners have watched too many kung fu movies.

Nov 15 03:25 PM