Chinese central bank under pressure
At the moment, China's monetary policy is a mystery to many of us. The nation's currency, the renminbi or yuan, has been tied to the US dollar for years. While it's no longer pegged to the greenback officially, it's moved to a managed floating exchange rate based on market supply and demand with reference to a basket of foreign currencies.
Like clockwork, day in, day out, the People's Bank of China (PBoC) fixes an exchange reference rate, allowing daily trading fluctuations of no more than 2 percent in either direction.
But then something unexpected happened: The central bank let the yuan plummet - three times in a row. On Tuesday, Beijing sent shockwaves through global markets when it decided to devalue the renminbi by some 2 percent - the most in two decades - while at the same time pledging to let markets have a bigger say in determining its exchange rate.
But just 24 hours later, it was at it again, depreciating its currency even further. The intervention sent the yuan plunging another 1.6 percent on Wednesday and another 1.1 percent on Thursday.
Have the guardians of the Chinese currency lost it?
The PBoC says it wants the yuan-dollar peg removed in the long term. Not because various US treasury secretaries have criticized that China has kept its currency artificially low so as to make its exports cheaper. Rather, because Beijing wants the renminbi to join other global reserve currencies, and it's fully aware that the International Monetary Fund will only allow the yuan access to the noble club of the euro, the greenback, the yen and the pound, if the yuan becomes fully convertible.
So why this latest dirigiste interference?
Old habits die hard
Could Beijing be returning to its old ways? An undervalued yuan makes Chinese exports cheaper around the globe, securing millions upon millions of jobs at home. Despite the government's long-term aim to wean the economy off its export dependence, it's not hard to understand why it would do almost anything in its power to prevent putting these jobs at risk.
The key to understanding Beijing's capers is to look closer at the way the PBoC plans to fix the exchange reference rate. While the central bank would continue to play a crucial role, the rate would have to reflect the previous day's closing value.
Revaluation a certainty
Assuming that the PBoC keeps its word and continues to allow a daily fluctuation corridor of plus or minus 2 percent, we could well see the yuan revalued by up to 2 percent per trading day. This would quickly reverse the downtrend of the past days, and appreciation pressures would persist.
However, the only way Beijing can afford betting on such a scenario is if the US central bank follows through on its plan to gradually raise its benchmark rates this fall. This would attract investors to the US, absorb capital from emerging economies and make the greenback stronger. If the dollar and the yuan were to rise in value simultaneously, their mutual exchange rate would largely remain stable, causing minimal damage to Chinese exporters.
China to say when the time is ripe
So far, China has used dirigiste means to try and prevent the yuan from devaluating, arguing the time is not yet ripe to let that happen. All state-controlled programs in China are carried out with a view to seeing a large middle class on the rise with a strong purchasing power so as to fuel domestic consumption and shift to more innovative, high-quality products. This would one day enable the nation to drastically reduce its dependence on exporting cheap mass-produced items.
But this can't be done overnight. If the yuan were to be freed from its fetters tomorrow, the value of the US dollar could be in for a 10 to 20-percent loss almost immediately. As a result, China's currency reserves would shrink considerably. But that would not be the biggest problem. Thousands of exporters would go bust, leaving millions of people without a job.
The Chinese government can't let this happen, desperate to avoid social unrest. China wants and will revalue the yuan, but it is Beijing itself calling the shots and deciding just how far it'll go. And it won't have anything dictated to them by others, and most certainly not by US treasury secretaries.
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