Yuan may begin moving again

I say moving, not appreciating, because as I've pointed out, if the Chinese end the U.S. dollar peg and diversify away from the U.S. dollar, they're going to be moving into weaker currencies. The only thing I'm looking for right now is the longer-term rally in the U.S. dollar and Chuck Schumer's blood pressure. But don't take my word for it on the yuan, even the Chinese are thinking the same thing.China Signals End to Yuan’s 23-Month Peg Before G-20
“The central bank’s statement means China’s exit from the dollar peg,” said Zhao Qingming, an analyst at China Construction Bank in Beijing. “If the euro continues to remain weak, it could also mean that the yuan may depreciate against the dollar.”

Here's just one of many articles that come out every few months from China, this one from November 2, 2009.
China Central Bank Opens Second Monetary Policy Unit
The People's Bank of China has established a new department to oversee exchange rate policy, sources told Caijing on Friday.

The department was scheduled to start operations on Friday, the source said, although this has not been confirmed.

The establishment of such a department indicates the significance of the exchange rate reform as a major issue in China's economic reform. Analysts believe the exchange rate policy is as important as the exit strategy for the moderately loose monetary policy.

The central bank said the department will formulate and implement foreign exchange policy, help develop an international yuan market, monitor international capital flows and advise the bank how to make the yuan convertible.

It will also take over management of the yuan settlement program operating among Hong Kong, Macau and five mainland cities that was previously administered by the bank's monetary policy and international affairs departments.
China has been increasing cross border settlements, using the yuan with more trading partners, foreign companies can now issue yuan bonds, etc. There is steady progress towards making the yuan a fully convertible currency, but it is proceeding slowly and prudently. The direction is unmistakably clear, but it's simply not fast enough for some people.

China ended yuan appreciation in 2008 and it's been re-pegged to the U.S. dollar since then. During the Asian Crisis, there was a lot of concern that China would devalue, but instead they held firm and generally one finds that this policy is described favorably. The recent policy is following the same logic. We've seen fluctuations in the euro destabilize markets and a change in the yuan policy during this time would probably have led to more volatility.

As the economy recovers (or is perceived to recover), crisis policy is no longer necessary. India is raising interest rates and other nations in the region are adopting similar stimulus exit policies as they see economic recovery ahead. China is clearly trying to deflect political pressure from the U.S., but they may also be more confident and looking to continue currency reform.

Here is China's statment, released ahead of the G20 Summit:
In view of the recent economic situation and financial market developments at home and abroad, and the balance of payments (BOP) situation in China, the People´s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility.

Starting from July 21, 2005, China has moved into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. Since then, the reform of the RMB exchange rate regime has been making steady progress, producing the anticipated results and playing a positive role.

When the current round of international financial crisis was at its worst, the exchange rate of a number of sovereign currencies to the U.S. dollar depreciated by varying margins. The stability of the RMB exchange rate has played an important role in mitigating the crisis´ impact, contributing significantly to Asian and global recovery, and demonstrating China´s efforts in promoting global rebalancing.

The global economy is gradually recovering. The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability. It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility.

In further proceeding with reform of the RMB exchange rate regime, continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market.

China´s external trade is steadily becoming more balanced. The ratio of current account surplus to GDP, after a notable reduction in 2009, has been declining since the beginning of 2010. With the BOP account moving closer to equilibrium, the basis for large-scale appreciation of the RMB exchange rate does not exist. The People´s Bank of China will further enable market to play a fundamental role in resource allocation, promote a more balanced BOP account, maintain the RMB exchange rate basically stable at an adaptive and equilibrium level, and achieve the macroeconomic and financial stability in China.
The statement references the recent uptick in China's trade balance, which led to outbursts of anger from Congress. But as the statement notes, they see the trade balance heading towards equilibrium, so don't expect much in the way of yuan appreciation.

Unfortunately for Congress, even if China let the yuan rise they may not see a decline in the U.S. deficit, with nations such as Vietnam looking to attract capital and factories to its market. There's a lot of debate about how the trade balance is calculated and the impact of global supply chains on the U.S. trade deficit, of which the yuan may be a component. Which is to say, Congress' simplistic notion of exchange rate policy is more about good politics rather than good economics.

And if the renminbi should fall against the dollar...I expect the Schumers and Grahams of the world, rather than having the egg on their face be the center of attention, will instead turn up the heat on China. At that point, the odds of protectionist legislation passing Congress could be quite high, and given the lack of leadership from Obama, it's not clear to me that he would have the ability to defeat them. He may not even oppose them at that point in time, since the policy may be popular if the economy contracts again.

Update: Another story that shows currency reform is ongoing: Cross-Border Yuan Settlement to Expand
After nearly one year of a pilot program, cross-border trade settlement based on the yuan will expand to 20 provincial-level regions in China and all of China's trading partners.

Heilongjiang, Sichuan, Jiangsu, Fujian and Yunnan are among the new regions that will join the cross-border yuan settlement program.

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