In July 2005, the Chinese government broke years of tradition by allowing its currency, the yuan (renminbi), to “float” against a basket of currencies.
Floating the yuan meant the value of the currency could fluctuate, just as most other world currencies do. Previously, the yuan had been “pegged” to the U.S. dollar, meaning its value vs. the greenback remained the same regardless of external factors.
However, China enacted a “measured” float, so the yuan could move no more than 5 percent a year. In the more than 18 months since the revaluation, the yuan has gained about 6.1 percent vs. the dollar, from 8.2865 to 7.7784.
Joseph Trevisani, chief economist at forex brokerage FX Solutions, believes the Chinese government is doing the right thing.
“The Chinese economy is perennially in danger of overheating,” he says. “They are preventing this from happening through the yuan.”
U.S. officials, though, have continued to pressure the Chinese for a more liberal float, one that won’t limit daily or annual moves. The UK and the Eurozone have also lobbied the Chinese for greater change, and there is even dissent among Chinese economists.
Blake Morrow, president of software firm 4X Made Easy, says China is not likely to be persuaded by outside pressure. In fact, such pressure may even backfire against the U.S. and others.
“They understand they are a part of the global economy, and they have already taken that into consideration,” Morrow says. “But the more pressure they get, the more they will hold their stance. They want to show their sovereignty.”
China’s government has so far refused to bow to outside pressure. However, in late January, it did soften its stance slightly, as the People’s Bank of China said it would increase the yuan’s float range. Nonetheless, the bank said its first priority was still the currency’s stability.
“China needs moderate, gradual growth in its currency,” Morrow says. “Most of their domestic exporters are working on a very thin margin, and too much change in the yuan could push them out.”
The PBOC did not specify the parameters of the loosening, saying only the yuan would continue to trade at a “reasonable level.”
Trevisani, though, doesn’t see the need for the Chinese to drastically change their approach. He believes the closely watched trade balance totals are a bit overrated, as they don’t track money put back into the U.S. for investment purposes.
“People have been worried about the trade balance for what, 30 years?” Trevisani says. “I don’t think what the Chinese are doing will be all that disadvantageous.
“Although they have a managed float, it is calculated daily, so they have a lot of flexibility,” he adds. “It makes sense for their economy.”
Still, Trevisani realizes China needs to be concerned with how their actions affect the global economy as well.
“They are starting to respond to that,” he says. “They have almost full participation in the global economy. They are not yet participating in the modern capital markets, but that is coming.”
Morrow says another reason for China’s hesitation is that the country has a high savings rate among its residences, and a large appreciation in the currency would lower the price of goods and services and make the Chinese more apt to spend and less likely to save.
“A lot of people think the yuan is still undervalued by 15 or even 30 percent,” Morrow says. “It’s at about 7.8 right now. I think the Chinese can manage it down to 7.5, but they don’t want to move it much more than that.”
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