Is China Going to Revalue the Yuan?

Speculation has intensified that China will allow the CNY to resume appreciation. As well as a move in USD/CNY NDFs, implied options volatility has also risen. Speculation of CNY revaluation follows a significant change by China’s central bank, the PBOC to its stated FX policy in its quarterly monetary policy report last week.

The timing of the change in rhetoric should come as little surprise as it coincides with greater international calls for a stronger CNY to help rebalance the global economy as well as an improvement in economic data domestically. China has so far resisted such calls but the time may now be right for China to play its part in the global rebalancing process.

Recall that China had allowed a close to 20% appreciation of the CNY between July 2005 and July 2008 but re-pegged to the USD as the financial crisis intensified. This policy proved to be the correct one during the crisis as a stable versus appreciating exchange rate not only helped exports but helped contribute to China’s economic resilience during the crisis.

Now however, this policy is no longer needed. The worst of the crisis is over and China’s economy is doing remarkably well. Keeping the CNY artificially undervalued may stoke potential inflationary problems and distort the recovery process whilst limiting the shift to a more consumer based economy. Managing China’s massive $2 trillion + of exchange reserves is becoming a more complicated and difficult process too. Moreover, the undervalued CNY is proving to be a global problem and hindering the adjustment of global imbalances.

Will there be an imminent revaluation of the CNY? China is in no rush to see the CNY appreciate and is unlikely to act when US President Obama is visiting. If anything, the Chinese authorities will renew the CNY appreciation trend when there is less political pressure as the last thing they want to do is to appear to be bowing to US or international pressure.

Yes the CNY is undervalued and the Chinese know this well. What is different this time is that the rest of Asia wants China to move and this is sufficient for China to act eventually but not imminently. The Chinese authorities are concerned about hot money flows and do not want to give the impression that they are embarking on an aggressive revaluation path. Gradual is the way to go but there is still room for markets to price in more appreciation next year.

What will happen during Obama’s visit is that the Chinese delegation will push for the US not to implement policies that will undermine the value of the USD especially in relation to the US fiscal deficit and the burgeoning Fed balance sheet. In return the US will push China into allowing the CNY to strengthen.

China appears to be in a stronger bargaining position given that China remains the biggest buyer of US Treasuries and the US will do little to jeopardise these investment flows. Perhaps China has pre-empted the US calls for a stronger CNY by changing the language in its monetary policy statement and it was likely no coincidence that the change happened just ahead of the US visit.

Comments

[Mad Hedge F...:]

afy Zachary Karabell, president of River Twice Research, is one of the few original thinkers out there who also has a sense of humor. So there’s more than one? Zach has brought his considerable talents to bear on the current state of the Chinese-American relationship in a new book, Superfusion: How China and American became One Economy and Why the World’s Prosperity Depends On It. International trade has fused the two countries into a single economic unit that accounts for a quarter of the world’s population and a third of its GDP, despite wildly different cultures, much like the loose confederation that makes up the European Community. The Middle Kingdom now has reserves of $2.3 trillion, which is overwhelmingly invested in the US. Where else can it go? That enabled them to step up and play an important role in the bail out of the US financial system this year. But it is an imbalanced agglomeration, with Americans over consuming and under saving and the Chinese doing the reverse. This has to stop, lest the symbiotic relationship tears itself apart. The tit for tat, storm in a tea cup, where the US imposed punitive import duties on Chinese tires and the they retaliated with a ban on American chicken feet (yes, they eat them, yuk!), is a recent example. The reality is that old, boring industries that once might have fought tooth and nail for protection are now migrating to China en masse and finding new life. Bet you didn’t know that General Motors sells more cars in China than in the US, some 1.6 million this year? Don’t hold your breath waiting for China to float the Yuan, as it is one of the few tools that give the Mandarins in Beijing direct control of a huge, disparate economy. Chinese military spending is so parsimonious that it won’t remotely comprise a threat to the US. What little they have is directed at potential regional aggressors, like Japan, India, and Russia. The greatest risk to the existing relationship is that Chinese growth continues so rapid, that it pits them against the world in resource bidding wars, which could get ugly. With crude at $82 and copper at $3, has that already started? The book is well worth a read for some excellent “out of the box” analysis. Does anyone have any good recipes for chicken feet?

Nov 16 01:34 PM

[Ben Gee:]

The relationship between the US and China today is simular to the relationship between the then superpower Great Britain and China 160 years ago. The British were also addicted to Chinese products it ran out of gold, the then reserve medium. Now, the US just print more money to buy Chinese products. 160 years ago, the Chinese neglected its defence, the British used opium as an excuse and invaded China not once but twice known as the two Opium Wars. People are wondering why China is building up its defence. India even predict China will invade India before 2012. Forget it, India. China do not want any of your problems. China has enough trouble with Tibet and Xinchiang and the addition of any part of India will create more trouble than it is worth. If China wanted to invade India, would China not had done it before India start making the Bomb? Japan? Will China invade Japan? After all, Japan invaded China, did it not? No. China will not invade Japan, Japan does not have any resourses. And China can buy anything from Japan. Why go to war? China can buy anything and from anybody except the US. The US think by not selling high tech to China, China will not by a rival. This is not funny, it is sad. Not for China, the US.

Nov 17 08:52 AM

[coreopsis:]

Just to add to the India comment by Ben.

Yes, indeed, Indian journalists have worked themselves into a lather frothing at the mouth about an imminent invasion of India by China.

This is quite laughable in view of the Chinese opinion that India has made the biggest mistakes of the developing world: no infrastructure, no manufacturing, inability to resolve conflict with its Muslim neighbors, and a rampant population growth that will soon lead India to be larger than China.

No, indeed, thanks but no thanks -- the Chinese want no part of India except to sell to them from the extensive list of goods that they don't have and don't produce.

In alternative energy, their wind turbine manufacturer Suzlon is the laughing stock of the world. I used to think that perhaps, in a spirit of cooperation, they would JV the manufacturing (maybe even engineering) of their lousy equipment to China, but I now think China wants no part of straightening out the Suzlon mess.

A strong and stable India is in the world's best interests, but flinging mud at your neighbors instead of doing real nation-building is not the path.

Could it be true that progress is limited in a country like India where strong, ancient religious beliefs in a 'democratic' context almost assuredly promise stasis? We're watching the US closely to see if a political system can, in fact, be driven by a group of people masquerading under the banner of God.


On Nov 17 08:52 AM Ben Gee wrote:

> The relationship between the US and China today is simular to the
> relationship between the then superpower Great Britain and China
> 160 years ago. The British were also addicted to Chinese products
> it ran out of gold, the then reserve medium. Now, the US just print
> more money to buy Chinese products. 160 years ago, the Chinese neglected
> its defence, the British used opium as an excuse and invaded China
> not once but twice known as the two Opium Wars. People are wondering
> why China is building up its defence. India even predict China will
> invade India before 2012. Forget it, India. China do not want any
> of your problems. China has enough trouble with Tibet and Xinchiang
> and the addition of any part of India will create more trouble than
> it is worth. If China wanted to invade India, would China not had
> done it before India start making the Bomb? Japan? Will China invade
> Japan? After all, Japan invaded China, did it not? No. China will
> not invade Japan, Japan does not have any resourses. And China can
> buy anything from Japan. Why go to war? China can buy anything and
> from anybody except the US. The US think by not selling high tech
> to China, China will not by a rival. This is not funny, it is sad.
> Not for China, the US.

Nov 17 10:24 AM

[Gregman2:]

China knows it must re-evaluate the yuan. It's just a matter of when. It will trigger enormous internal re-evals within China (including in Hong Kong/Taiwan). They would opt to do this through a gradual process, if possible, since this currency re-set will have such a major impact on asset valuations and foreign investments.

Nov 18 02:11 AM