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Perspectives on Allowing Yuan to Float Freely
In 2007 China recorded trade surplus at a whopping 11% of its GDP. In December 2007 People’s Bank of China (PBC) held foreign exchange reserves of 1.5 trillion USD in addition to over six hundred tonnes of gold. In December 2009 PBC held foreign exchange reserve of 2.4 trillion and about 1100 tonnes of gold. PBC had been keeping most of its foreign exchange reserves in US treasuries. Its purchases helped keep USD high and US rates low. US on the other hand have been running huge trade deficits. Pundits felt /feel that such imbalances in global economy introduce a pronounced element of instability and are undesirable.
American establishment’s (not American economists’) view has been that China must revalue its currency. Let us take a look at EER’s of USD and yuan. Nominal EERs are calculated as geometric, weighted averages of bilateral exchange rates. Real EERs are the same weighted averages of bilateral exchange rates adjusted by relative consumer prices. EERs computed by different organisations follow broadly the same principles but their arithmetic may be a little different. Difference arises on how to attach weights. For example IMF’s and BIS’s computation of REER / NEER of different currencies do not give the same numbers over same periods. This chart is drawn from REER computed by BIS.
During 1994-2010 yuan has appreciated by over 40% on REER basis whereas USD has come back to square one after rising 20% around 2001. But as mentioned above REER is computed with weights based on trades with different currency areas. The weights change from year to year and REER may show a rising / falling trend because of the changes in relative trades with different countries. Nevertheless, the popular standard (and not necessarily correct) prescription in face of rising REER is to allow the currency to depreciate. What do you say –should China depreciate yuan?
China has large trade surplus, United States has large trade deficit. Is it fair to insist on China to manage the global imbalance and not ask the US to do the same? And should the rebalancing be achieved by allowing yuan to rise against the dollar? On broad multilateral exchange rate basis, in real terms, yuan has risen by about 10% this year (2010).
What would happen if China were to sever its de facto peg with dollar? Will yuan appreciate against USD? Will it depreciate? Depreciation is not all that farfetched. Roubini has said that as yuan has risen sharply in recent months against the euro, so a stronger yuan could not be taken for granted. If the euro were to continue to depreciate, yuan would have to be allowed to depreciate against the dollar. The same views were earlier made by Li Daokui, an academic adviser to the monetary policy committee of the People's Bank of China - the yuan could depreciate against the dollar if the euro falls sharply against the U.S. currency.
There is yet another angle. China has not only kept yuan pegged to dollar, it also has very low lending and deposit rates. Such artificially low rates mean systemically robbing the households to pay to the corporates leading to low domestic consumption level. Suppose China were to increase deposit rates and allow yuan to float. Do you think it will go up substantially against USD?
American establishment’s (not American economists’) view has been that China must revalue its currency. Let us take a look at EER’s of USD and yuan. Nominal EERs are calculated as geometric, weighted averages of bilateral exchange rates. Real EERs are the same weighted averages of bilateral exchange rates adjusted by relative consumer prices. EERs computed by different organisations follow broadly the same principles but their arithmetic may be a little different. Difference arises on how to attach weights. For example IMF’s and BIS’s computation of REER / NEER of different currencies do not give the same numbers over same periods. This chart is drawn from REER computed by BIS.
During 1994-2010 yuan has appreciated by over 40% on REER basis whereas USD has come back to square one after rising 20% around 2001. But as mentioned above REER is computed with weights based on trades with different currency areas. The weights change from year to year and REER may show a rising / falling trend because of the changes in relative trades with different countries. Nevertheless, the popular standard (and not necessarily correct) prescription in face of rising REER is to allow the currency to depreciate. What do you say –should China depreciate yuan?
China has large trade surplus, United States has large trade deficit. Is it fair to insist on China to manage the global imbalance and not ask the US to do the same? And should the rebalancing be achieved by allowing yuan to rise against the dollar? On broad multilateral exchange rate basis, in real terms, yuan has risen by about 10% this year (2010).
What would happen if China were to sever its de facto peg with dollar? Will yuan appreciate against USD? Will it depreciate? Depreciation is not all that farfetched. Roubini has said that as yuan has risen sharply in recent months against the euro, so a stronger yuan could not be taken for granted. If the euro were to continue to depreciate, yuan would have to be allowed to depreciate against the dollar. The same views were earlier made by Li Daokui, an academic adviser to the monetary policy committee of the People's Bank of China - the yuan could depreciate against the dollar if the euro falls sharply against the U.S. currency.
There is yet another angle. China has not only kept yuan pegged to dollar, it also has very low lending and deposit rates. Such artificially low rates mean systemically robbing the households to pay to the corporates leading to low domestic consumption level. Suppose China were to increase deposit rates and allow yuan to float. Do you think it will go up substantially against USD?
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Comment by Bill M Wright on July 4, 2010 at 7:34pm -
On this America's July 4th Independence Day allow me to say...There is nothing "FREE MARKET" about China's currency fixing anymore than China's One Communist Party system is "FREE DEMOCRACY". There is no FREE MARKET Economic Principle that I can find which says free trade involves one trading partner fixing its currency againest its trading partner. Surely no one is foolish enough to believe China pegs its currency to the dollar to benefit America. The objections of those American tenure socialist economics college professors and capitalist economist is in reference to Trade Wars. Everyone has a financial self interest to protect. I've not heard one American economist rationalize that China Price Fixing its currency to the dollar is a Free Trade Economic Pinciple have you?
June 23 (Bloomberg) -- China’s yuan is almost 50 percent undervalued against the dollar, Credit Suisse Group AG said.
Yuan Is About 50% Undervalued Versus Dollar according to Credit Suisse. Mr Garthwaite Says, The Chinese currency will appreciate more than 2.7 percent “discounted by the forward curve over the next 12 months against the dollar,” Andrew Garthwaite, global equity strategist, said in a note to clients. It should also be noted that Currency Day Traders what to make 1/2 % moves up or down sound like wild swings soaring up or crash downward. Just endless daily yacking to get more people trading FOREX. In reality I don't believe we've had any real wild swings.
What would happen if yuan were allowed to float you ask? China knows it would make them less competitive and they'd need to layoff a few million people. You do recall the loss of jobs riots back in 2008 in China. As you know they openly endorse age discrimination because their labor force is so large and they want only the youngest slaves cranking out the most production to the west in their factories. If your over 35 your wasting your time looking for a factory job in China.
Still, as always, I must applaud China's Communist Party of Central Planners....they have done better than any Western Decentralized Democracy in bringing jobs to their country. They have proven American Republicans dead wrong. Big government and Centralized Planners can bring economic prosperity to their people by playing the Capitalist game.
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Comment by Investor Boot Camp Online on July 5, 2010 at 9:51am -
The timing of a free floating Yuan is going to influence its price trend relative to the U.S. dollar. The Chinese government has pegged their currency because it is in their interest to do so. Think of it as an emerging company that is trying to capture market share.
Eventually, that strategy is maxed out and a different strategy makes sense. In China's case, they will float their currency when it suits their economic policy. When that happens the Yuan is likely going to decline rather than rise.
With a floating currency trillions of dollars (i.e. Yuan as measured in dollars) will be free to leave China. That will be their first opportunity to do so. The flood of money leaving China will have an intermediate term impact with downside pressure on the Yuan.
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Comment by Srikanth S on July 11, 2010 at 10:53pm
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I could not wholeheartedly agree with Bill on the impact of the floating yuan on jobs, unemployment and china's trade deficit. The hoarding of US treasuries and gold by China and the pegging of the yuan to be undervalued relative to the dollar has been a good job creation tool in China and has caused the progressive shift of manufacturing away from the United States over the past 2 decades.
While this economic strategy has been working well for China in isolation, now it is time to remove these artifical barriers to "free" trade. "Free" trade can create the greatest economic surplus and Chinese monetary authorities most obviously are well aware of this fact. Diplomatic pressure is necessary from the international community in order to force the Chinese Government to relax its "pseudo-protectionist" stance and level the competitive playng field across the globe. My 2 cents and hope Andy Grove could concur.
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