Why China's Unpegging of Yuan Is a Sham

| About: WisdomTree Chinese (CYB)

China has announced very vaguely so far that it will let the yuan float “somewhat” against a market basket of currencies. This likely means a market basket of the currencies of its biggest trading partners. Six that are virtually certain to be included are the USD, the euro, the yen, the won, the real, and the AUD. I’m sure there will be many more.

Is China going to one-off appreciate the yuan? They say no. Is China going to allow the yuan to free-float against this market basket of currencies (like a USD Index)? Again, they say no. This will be a controlled pegging of the yuan to a basket of currencies instead of just one. China says it will allow some floating of the yuan against this basket of currencies. In the next breath it says it will control such a float very carefully.

To me, this all means that China is playing politics. To me, it means that China will try to weight the currencies based on their percentage presence in China’s trade, and then it will allow the USD to go up as the euro goes down relative to the yuan. It seems a way for China to lessen the rapid appreciation of the yuan versus the euro, as has happened with the yuan pegged to the USD.

This could actually result in the USD appreciating against the yuan. For instance, if the euro were weighted as 20% and the USD were weighted as 14%, then keeping the yuan Index relatively stable would in effect cause the USD to appreciate more rapidly against the yuan than it does against the euro. This is currency manipulation. There could be no underlying reasons to the USD to appreciate against the yuan. Yet using this system the USD would go up versus the yuan.

This is in no way a move towards fairness. The USD is not going to be allowed to free-float against the yuan. Instead, this seems a move to prevent China from getting hurt by a major currency move by one or more of its major trading partners. The effective pegging will still be intact. However, China will not suffer as much loss of trade due to its rapid appreciation against the euro (the yuan, which is pegged to the USD, has rapidly appreciated against the euro recently).

Instead, China will argue its need for a stable yuan Index. It will keep the yuan Index relatively stable. If China uses relative weightings (as I am postulating) it will be forced to push the USD (and perhaps others) up to compensate for the fall in the euro. It will let the USD and the euro move rapidly, but it will insist that it needs to keep control of its currency. Is this an unpeg? It’s not to my mind. It is also not a one-off appreciation of the yuan. If the US and Europe do not deserve to control their currency versus others, why does China? It is on its way to being the largest economy in the world.

To my mind this is a sham. It is an obfuscation of the reality of pegging the yuan. The yuan may be allowed to move a little, but this system sounds designed to function in much the same way as the peg to the USD, except now the peg is to a market basket. This system can still hold the yuan below market value. This system (or what I have heard of its so far) is still mercantilism in every sense. It is still economic imperialism. If China was going to allow its currency to-free float, it would say so. That is not the case.

If you, as a US businessman, believe the USD is likely to go up versus the euro in the near-term, this is likely very negative news for you. It may mean exporting to China will be that much harder. It may mean Chinese goods will be that much cheaper. This spells trouble for US businesses. Far from being a solution, it may worsen the problem. China is not promising a free-floating currency anytime soon. It is merely promising to be self-serving. It is promising to control its currency in a way which works in China’s favor. If you think this is a break though toward a free-floating currency, you will likely be sadly disappointed. If you think US businesses will benefit, you are likely to be disappointed.

Is this good news for the US? In the short-term it does not seem so. It could possibly year hence lead to a more free-floating yuan. However, for now, a peg by any other name is still a peg. It is still mercantilism. It is a method that will make US businesses absorb bigger swings in the yuan, but it keeps things steadier for China. With this system, the “too lowly valued yuan” will be allowed to go even lower versus the USD if the euro falls farther. This is a system tailored to China’s needs. It exposes the US to even bigger abuses. It effectively promises nothing to the US, but it gives China extra protection against the currency moves of its major trade partners. This is again economic behavior economists object to.

China is not a small impoverished country. It is one of the biggest players on the world stage. The world needs to insist that it take no extra advantages that its peers do not get. Smoothing out its overall currency moves by effectively pegging to a market basket is just another bullying tactic by China. Some may say, doesn’t the US do this? No! The US allows its currency to free float against all of the major currencies of the world. It does not try to control the USD Index. That index is just a reflection of the various movements in the individual currencies.

China’s new proposal sounds instead like just another method of pegging its currency. If this proves to be the case, the USD will go up if the euro goes down, irrespective of any economic factors involving the US and China. On top of that, the euro will likely have a higher percentage of weighting that the USD in the Yuan Index. This is the antithesis of free-floating. Instead of a step forward, this may be a step backward. It scares me that it may be an obfuscation that works.

Of course, I am basing my comments somewhat on information that has yet to be completely released. The Chinese can still change the exact implementation. Still, I feel readers deserve to be warned they are likely being scammed again.

Disclosure: No positions