Pressure to revalue

Nonetheless, pressure is building in the international community for China to open its currency to market forces. “China is moving from being a small closed economy, where a forex peg is suitable, to a large open economy where a flexible exchange rate is needed,” says Cairns. “China is already by far the largest economy in the world with a U.S. dollar peg.”

With the U.S. dollar in a massive bear market in recent years, falling from around $0.83 vs. the Euro to around $1.36 in late 2004, the renminbi has been depreciating along with it.

“The Chinese renminbi is undervalued,” says Cairns. “The current account balance was 44 billion in 2003 and rose to an estimated $55 billion in 2004 and should hit as much as $65 billion this year. Combined with massive capital inflows, this implies the authorities have to buy more than a hundred billion U.S. dollars a year to keep the peg intact. This, in turn, injects liquidity into the monetary system, leading to much-too-rapid monetary growth.”

Europe has been in favor of a revaluation, if only to relieve some of the upward pressure off the Euro, which has been in a massive bull market vs. the dollar since 2002 (see the weekly EUR/USD chart in.

Analysts and traders have a wide range of views on potential revaluation of the renminbi. Some economists believe a modest revaluation can be expected in the first half of 2005, while others believe the Chinese will refuse to be pressured into a currency shift.