Last weekend in Beijing, the governor of the People's Bank of China, Zhou Xiaochuan, gave an interview to the Chinese financial magazine Caixin. During this interview, Zhou detailed China's currency strategy, the country's macro outlook, and some forward guidance. One of the big takeaways from the interview is that China wasn't bluffing when it called out George Soros.
The interview with Zhou (pronounced like "Joe") went into detail regarding many aspects of China's monetary policy, which started off with a stated understanding of the global economic slowdown and volatility in international financial markets. Zhou also discussed the strength of the Chinese economy, which relevant to other economies is still growing at among the highest rates in the world, and is contributing close to 25% of global GDP growth. This on-going strength in the Chinese economy comes at a time when the natural economic cycle of the country is slowing down, potentially exacerbated by the global economic environment.
Zhou Xiaochuan's Take on the Yuan Exchange Rate
During the interview, Zhou named four key factors that he sees as being mostly responsible for movement in the Yuan's exchange rate. They are:
- Residual effects from the financial crisis
- Fed exiting monetary policy
- Speculative (negative) forces targeting China
- The global asset bubble created by loose monetary policy
This list of factors affecting the Yuan's exchange rate could really be condensed to two factors: the Fed's policy, and speculation. From his perspective it seems that the Fed, in the aftermath of the financial crisis, pursued monetary policy that led global investors to drive up asset prices, now that the Fed has reversed course and other central banks are going negative, investors are selling more or less anything.
In the type of rhetoric we have seen from Chinese leaders or media before, Zhou took a chance to mention that short-selling speculators are always looking for something to bet on, and saw China as a good target due to its role in the global economy. These speculators have gone around trying to create hype and momentum for their short term gain, despite the overall strength of the Chinese economy.
For Zhou and the Bank of China, they are playing a long game focused on fundamentals and patience. While they recognize the calamity that has befallen the global markets since December, they are more focused on the real economy than financial markets, and they don't seem to be willing to let speculators push the Yuan down without just cause.
In a related part of the interview, Zhou did say that the Bank of China was committed to the country's 13th 5-year plan; which, among other things, laid out a plan for reforms that would culminate in the exchange rate regime being almost completely run by market forces. However, in the short term China will continue with its managed float regime that will consider all the market forces in play to determine an appropriate exchange rate. This means that the Bank of China will take into account inflation, balance of payments, supply and demand, the capital account and the whims of speculators.
Part of the reason we shouldn't expect a completely free floating Yuan any time soon, Zhou said, is because:
We have always held the view that the efficient market hypothesis cannot be relied upon 100 percent. A market deficiency may demonstrate itself from time to time when the market is dominated by speculative forces, short-term sentiments or herding behaviors, and therefore certain management is necessary for a floating exchange rate. Our aim is to have the exchange rate broadly stable at an adaptive and equilibrium level, and there are interactions between the two.
Burning Soros and the Speculators
With this guidance from the head of the People's Bank of China, the Yuan was set at 6.5118 per USD on Monday morning, its strongest reference rate since Jan. 4th and down from its weakest point in recent history, near 6.60 Yuan/dollar. Clearly the BoC is trying to lead the currency towards a more stable level, closer to 6, not 7. Part of this might be to burn speculators, but it is most probably aimed to increase confidence in the Chinese economy.
Some banks have put out year-long forecasts for the Yuan to fall against the dollar, with some speculating that by year end we will see 7 Yuan/dollar. From Zhou's remarks to Caixin over the weekend and the reset for the exchange rate, it seems the Bank of China is not keen to play along with this devaluation. Quite the contrary, the BoC seems keen to push back hard against short-sellers until the exchange rate reaches a more stable equilibrium.
Look for the BoC to squeeze the bears out, and push the Yuan back to 6.29-6.33, the range it has been in most of the past 3 years.
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