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China Currency Appreciation

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1 China Currency Appreciation on Wed Mar 24, 2010 1:17 pm

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China Currency Appreciation
by Francis Cianfrocca

This story is pretty significant. Remember I told you the other day that our sabre-rattling on the currency issue put the Chinese in a spot where they have to delay doing what both we and they want them to do? They’ve been delicately planning to allow a revaluation for months, but when Paul Krugman, Obama, Schumer et al pile onto them, they have to posture angrily and say everything is fine as is. It shouldn’t take much to understand that they have a govt that’s too weak to afford to appear to be bowing to US pressure.

Anyway, a few days later and right on cue, some Chinese business leaders have stepped up to say that a revaluation is needed. This adds to the cover the leadership have to make a badly-needed move that nonetheless must appear to have been done because they wanted to, rather than because we told them to.

The steel executive quoted in the story pointed out something really important: there are two sides to an undervalued currency. If you’re just trying to be a mercantilist power and you can export products made with near-costfree native labor, then undervaluation is a beautiful thing. When you’re trying to build the most modern cities in the world in the blink of an eye, undervaluation kills you on the cost of iron ore, coal, copper, oil, and all the rest of the raw materials and semi-finished goods you need to import.

More interesting to me is that the government have recently given permission to certain bank locations to settle trade accounts in yuan rather than US dollars, HK dollars, Aussie dollars, yen, or whatever. The value of these settlements has reached the equivalent of a billion dollars since the beginning of this year. Peanuts, but new and different for a country that deeply fears inflows of hot money.

If it’s possible for non-Chinese to hold yuan balances, then China is de facto allowing their currency to float. Because as night follows day, those deposits will be traded at market exchange rates and attract market rates of interest. (Think of something like the Eurodollar market, coming to East Asia.) The Chinese don’t fear the resultant inflows as much as what will happen when they reverse. Given the unsettled state of their internal credit conditions, they’re right to have such fears.

They would like to be able to raise interest rates to quell their suddenly-worrisome levels of inflation, but the undervalued currency gives them no room to do so.

But they can’t keep running the world’s most dynamic economy on piggybanks and Monopoly money for much longer. If they loosen up their currency regime, then their banks will have to get more disciplined, because they’ll be exposed to market interest rates. That will make them better as banks, but worse as channels for transmitting government policy.

It’s kind of funny, how the Chinese have approached this. We went from laissez-faire in the 19th century to a moderately controlled financial system in the 20th. In the 21st, we may soon install trade protectionism and controls to inhibit capital flight as the real value of our money deteriorates. Although the Chinese will never go all the way to laissez-faire, they seem to be following our path in reverse.

And if convertibility comes, I’ll be adding renminbi to the Canuck bucks and Swiss francs I’ll be holding instead of dollars. Although I’d feel better about it if they took the foul murderer Mao’s picture off their banknotes.

2 Re: China Currency Appreciation on Wed Mar 24, 2010 1:31 pm

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