China, Gingerly, Comes To The Currency Party

Includes: CNY, FXI
by: Emerging Money

By Sean Geary

The Chinese government announced this weekend that it would widen the band within which the Chinese Renminbi trades. Along with bank liberalization, allowing the RMB to trade more freely is considered to be an integral step forward if China wishes to become a global financial hub. On Saturday, the Chinese government declared that it will now allow the currency to move 1% upwards or downwards in a single trading day, up from the previous range of .5% daily.

The Chinese government has long kept the RMB in check by pegging it to a basket of currencies. Foreign governments have complained ad nauseum that this practice has artificially depressed the value of the RMB and has afforded Chinese exports an unfair advantage.

However, in light of the most recent move, countries like Japan and multilateral organizations like the IMF and World Bank have applauded the incremental currency liberalization.

Further, the Wall Street Journal argues that this trading band increase indicates that the Chinese government feels that the RMB is trading at close to fair value, even though a number of Western economists and hedge fund managers had predicted a gradual rise in the RMB over the long-term.

As the result of declining Chinese trade surpluses however, these investors may have to reconsider the validity of their RMB thesis.

In spite of the pervasive notion in the West that the Chinese currency is undervalued, the RMB actually traded lower Monday, indicating that traders fear that potential slowing growth in China and a potential capital exodus if currency restrictions are further dismantled could see the RMB move lower.

Currency traders looking to play the RMB should do so carefully. The Chinese government can be somewhat capricious, and a sustained appreciation in the RMB could see the government backtrack. On the other hand, a large move to the downside could stoke inflationary pressures, which the government would obviously be keen to curtail.

Thus, long-term positions are a difficult call here. In the short-term, traders under the impression that the Chinese economy is in for a slowdown could short the RMB as a proxy for receding growth. Conversely, traders who believe that talk of a Chinese hard-landing is overdone may want to go long the RMB against the dollar.