The Chinese government surprised the world on July 21 by announcing it would let its currency, the yuan or renminbi (RMB), rise in value by 2.1% to 8.11 RMB to the U.S. dollar, after eleven years of pegging it at 8.28.
The official RMB-revaluation announcement by the People’s Bank of China (China’s central bank) is laden with laughable oxymorons such as improving a “socialist market economic system” and introducing a “managed floating exchange rate regime.”
Just as significantly, the government ceased fixing the RMB solely to the U.S. dollar and is now pegging it to a “basket” of currencies. None of these currencies have been named, apart from the greenback, nor have their respective weightings been revealed. (The unique currency of Hong Kong, however, will remain solely pegged to the U.S. dollar.)
Thirdly, the Chinese government is now allowing the RMB to float against the U.S. dollar each day within a band of +/-0.3% around the previous trading day’s close, which is still being determined by the government. Against the remaining currencies in the basket, the RMB will be allowed to fluctate +/-1.5% per day.
It’s widely seen that the RMB revaluation will do little to dampen China’s red-hot economy, which officially saw a 9.5% increase in gross domestic product in the second quarter. At the same time, annual inflation was just 1.6% in June, at least officially.
Local trading in the RMB was muted the day following the revaluation announcement, with reports of strong interference by the Chinese central bank, presumably in order to dampen expectations of any further rises in the near future.
Outside China, market reaction to the RMB exchange-rate news was predictable: in the U.S., the dollar fell against most currencies and U.S. ten-year treasury bill yields rose 12 basis points to 4.27% (since presumably, the Chinese will now need to buy fewer U.S. treasuries to peg the RMB); the yen scored its biggest rise against the greenback in three years; and the currencies of China’s neighbours and commodity exporting countries, such as Canada and Australia, rallied.
For Western miners, the RMB appreciation is obviously good news, since it means the Chinese can afford to import even more mineral products — the one sector of China’s imports that’s showing no signs of slowing down.
China remains a major mineral importer and the main driver of global metal demand growth (aluminum being the only major metal for which China is a major exporter).
With China’s current industrialization likely to take another ten to fifteen years to complete, metal prices look poised to remain firm for many years to come.
While the mechanics of the new RMB system are deliberately unclear and all the old currency controls remain firmly in place, the RMB has risen significantly, though nowhere near as dearly as many in the U.S. — and elsewhere — have demanded during the previous two years.
These critics rightly see that the Chinese government has been creating massive distortion in the global economy by undervaluing the RMB by 20-40% compared with the U.S. dollar. This allows the authoritarian Chinese government to dramatically underpay its workers in order to kill manufacturing capacity in competing countries. Anyone who’s watched textile jobs move in the last two decades from Canada and the U.S. to Latin America, and now from Latin America to China, can see that this industrial strategy is simultaneously vapourizing jobs in the Americas and making the Chinese government more powerful.
Debt-laden U.S. homeowners, especially, should cringe at the revaluation news: higher bond yields invariably mean higher mortgage rates, which will translate into a quicker end to the Great American Real Estate Boom.
But anyone who thinks this latest RMB revaluation will soon lead to a series of rises is dreaming: China will “right-size” the value of the RMB only after its current monetary policy has deeply and irreversibly damaged manufacturing capacity outside its borders.
Only when that has been achieved will the Chinese government raise its currency, leading to one of history’s largest-ever transfers of wealth, with the West on the losing end.
As a taste of things to come, China now has a foreign exchange reserve of US$711 billion (second only to Japan) and is moving beyond just buying U.S. treasury bills, and is angling to buy major American assets such as oil firm Unocal and appliance manufacturer Maytag.
China’s leaders are deep, long-term, strategic thinkers, in stark contrast to our own politicians and captains of industry, who, more often than not, can’t think beyond the next election or their stock-option expiry dates. And China’s leaders have said for years that the RMB will one day trade freely on world markets, but the timing will always be based on China’s economic needs — not foreign pressure.
So the timing of this RMB revaluation appears far more political than economic, serving to take the wind out of the sails of the U.S. anti-China lobby ahead of the September visit to America by Chinese President Hu Jintao.
Interestingly, Malaysia quickly followed China’s lead and abandoned the pegging of its own currency, the ringgit, at 3.8 to the U.S. dollar. It is now pegging it to a similarly vague basket of currencies.
Malaysia’s U.S.-dollar peg was adopted in 1998 in response to the Asian financial crisis, which saw sharp declines in freely traded Asian currencies such as the Thai baht. Currently, 30 countries, including Saudi Arabia and Ecuador, peg their currency to a single currency, principally the U.S. dollar.
While a small fish, Malaysia does carry clout within the Islamic world as a country that has its fiscal house in order. Malaysia’s move away from the U.S. dollar and its long-time promotion of the Islamic gold dinar will resonate with its Muslim brothers, and so is dollar-negative and gold-positive.