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China will not be bullied into revaluing the yuan

|Includes: CNY, ERO, FXE, iShares China Large-Cap ETF (FXI), TLT, UUP

 China will eventually let the yuan rise, but not because its trade partners told Beijing to do it. When China's leaders let the yuan rise it will be because they perceive it to be in the interest of the political establishment.

With the US Treasury due to issue its annual report on currency manipulators soon and elections around the corner, a new rash of China bashing has broken out in Washington. But China insists as much as ever that the yuan is not undervalued. As a result, a dangerous game of brinkmanship has emerged at the heart of the most important economic relationship in the world, raising the chances of a nasty trade war.

The new push in Washington for sanctions against China is more about domestic politics than anything else, with China an easy target for politicians eager to build up political capital ahead of the mid-term elections amid high unemployment and general anxiety about China's rise. But likewise, China's refusal to revalue the yuan is also driven by Chinese politics. Chinese leaders don't want to be perceived by the population as kowtowing to the United States or other western countries, which would undermine their credibility and make cracks in their power.

It is frequently said of China that the Chinese have a much longer sense of history than in the West, which makes them see the world through the prism of history. Therefore, the Chinese consider it vital to put the last 200 years of foreign domination behind them and restore China's position as one of the world's pre-eminent powers -- a position China enjoyed for millenia until the Europeans arrived. Prior to the arrival of Europeans, the Chinese leadership considered it to be at the centre of the world, literally the Middle Kingdom. However, a student of Chinese history will quickly see that the central powers have long struggled to maintain authority over the country and surrounding territories, causing the imperial leadership to frequently collapse and uprisings to break out.

The current Chinese leadership know that to retain authority, and therefore credibility, with the population they must firstly deliver prosperity through rapid economic development and secondly they must be perceived as restoring China to its former glory as a pre-eminent power. And, as Americans themselves know perfectly well, pre-eminent powers do not let their policies be dictated by foreigners.

That is why the Chinese leadership are refusing to re-value the yuan even as it increasingly makes sense for the Chinese economy. With inflation in China becoming a problem and asset bubbles getting bigger every day, relaxing the yuan's exchange rate makes good economic sense. But it does not yet make good political sense. It will make political sense when the economic damage from the yuan's overvaluation becomes more of a domestic threat to the Chinese leaderships credibility than the perception in China that revaluing the yuan is kowtowing to Washington and other foreign powers.

In the mean time, bullying China to revalue the yuan can only be counterproductive because it would only make the Chinese leadership look weak if they actually did it.

Disclosure: no positions