Chinese revaluation: Better never than late?

The foreign exchange market is in a tizzy over whether China will revalue its currency, the renminbi, sometime soon — meaning, before the end of this year, or maybe even during the first week of May, which is a holiday week in China and Japan.

The current situation is a rich stew of economic, financial, and political factors, with a dash of history and a dollop of gamesmanship thrown in. U.S. and European politicians are screaming for measures to punish China for excessive exports. For a few weeks in April, Chinese citizens prompted in part by Japan’s bid for a permanent seat on the U.N. security council — staged mass protests of Japan’s refusal to take responsibility for war crimes and vandalized Japanese businesses and embassies.

How likely is a renminbi revaluation? In the end, the revaluation decision is a Chinese one, and we may not be able to incorporate all the factors they do.

In a nutshell, the Chinese would be ill advised to revalue their currency by a meaningful amount, now or later, let alone move from a fixed rate to a truly floating one. Doing so doesn’t serve their immediate self-interests, although it is a truism of economics that an artificially fixed currency rate results in misallocation of resources and various inefficiencies.

In fact, recent words from Federal Reserve Chairman Alan Greenspan are what set off the latest round of speculation about the timing of a revaluation.

In late April, Greenspan said the fixed renminbi is detrimental to China because it causes imbalances in China’s economy, and should be relaxed “sooner rather than later.” The same day, Treasury Secretary John Snow said “the time has come” to let the renminbi revalue.

These comments seem mild, but in the world of international diplomacy they are dynamite — and they induced a staggering response.

Two days later, Zhou Xiaochuan, head of the Chinese central bank, said, “If there is more pressure from outside, it may force us to speed up our reform. I always think that pressure is not a bad thing. It is often a driving force that pushes you to do your work better.”

This was a shocking about-face from China’s previous attitude toward outside pressure. Zhou added, “We have a very clear target in this regard, but we have our own sequence. We are doing some preparation, for example the reform of the financial sector, to enlarge the role of the foreign exchange market.”

Finally, Zhou said “there were no serious political or technical obstacles to revaluing the yuan.”

No serious obstacles? This assertion is simply not true. By examining why, we can more readily understand why the probability of a large and meaningful renminbi revaluation any time soon is very remote.