Forex yuan trading
Over the last six years, the appreciation of the Chinese Yuan has been as reliable as a clock. There is no other currency that I know of whose performance has been so consistently solid, and best of all, risk-free! As I wrote in an earlier post on the subject, the economic case for further appreciation is actually somewhat flimsy. While prices for many services remain well below western levels, prices for manufactured goods already equal or exceed those that Americans pay. As a resident of China, I can assure you that this is the case! Given that Chinese GDP per capita a proxy for income is 12 times less than in the US, that means that relative price levels in China are already significantly greater than the US. Thus, further appreciation would only cause further distortion. Even futures contracts — which typically lag actual appreciation because of their non-deliverable nature — are pricing in higher expectations for appreciation. Even though the Yuan is not fully-tradeable, its continued rise has serious implications for forex markets. First of all, there will be follow-on effects for other currencies. Almost every emerging market economy competes directly with China, and all are thus keenly aware that China pegs its currency against the US dollar. By extension, many of these economies feel they have no choice but to intervene daily in forex markets to prevent their respective currencies from appreciating faster than the RMB. At the very least, the appreciation in Asian yuan Latin American currencies will keep pace with the Yuan: All of this action will cause the dollar to depreciate. Even worse is that this cause a broad loss of confidence in the dollar, driving the dollar lower across-the board. China, itself, has unloaded part of its massive hoard of US Treasury securities for five consecutive months. The implications for how long-term investors should position themselves are clear. Unfortunately, while further appreciation in the Chinese Yuan is all but guaranteed, achieving trading to this appreciation is beyond difficult. Neither of the ETFs that claim to represent the Yuan CNY, CYB have budged over the last couple years, and they are a poor substitute for the actual thing. In other words, your only chance for exposure is indirectly via Chinese stocks and bonds, which are far from transparent and an extremely dubious investment. Otherwise, emerging market Asia seems like a pretty good proxy. Of course, you need to be aware that even though the Korean Won, Malaysian Ringgit, Thai Baht, New Taiwan Dollar, Indonesian Rupiah, Philippine Peso, etc. The Chinese yuan has appreciated by more than For China-watchers and economists, that the Yuan will continue to appreciate is thus a given. There is no question of ifbut rather of when and to what extent. But what if the prevailing wisdom is wrong? What if the yuan is now fairly valued, and economic fundamentals no longer necessitate a further rise? We can, however, attempt to analyze the economic sense of it. China manipulates the value of the yuan in order to give a competitive advantage to Chinese exporters, goes the conventional line of thinking. Look no further than the Chinese trade surplus for evidence of this, right? With this in mind, why would the PBOC even think about allowing the RMB to appreciate further? According to one perspective, the narrowing trade imbalance is only temporary. When commodities prices settle and global demand fully recovers, a wider trade surplus will follow. As a resident of China, I can certainly attest to this phenomenon, and the last few years has seen an explosion in the number of cars on the road, domestic tourism, and conspicuous consumption. A better argument for further RMB appreciation comes in the form of inflation. By raising the value of the yuan, the PBOC can blunt the impact of rising commodities prices and other inflationary forces. Others think that a once-off appreciation would be more effective, and is hence more likely. For the record, I think that the Chinese yuan is pretty close to being fairly valued. That might seem like a ridiculous claim to make when Chinese wages and prices are still well below the global average. As income per capita rises, currency trading cuts loose from underlying current account transactions…moreover, currencies with either high or very low yields attract more trading, consistent with their role as target and funding currencies in carry trades. In theory, one would expect a close correlation between forex turnover and trade. In fact, this turns out to be precisely the case for lesser-developed countries. Since the capital markets of such countries are commensurately undeveloped, offering limited opportunities for foreign investment, most of the demand for their currencies stems directly from trade. In fact, the currencies of Malaysia, Indonesia, Saudi Arabia, and notably China closely fit this profile, with a 1: At the same time, the BIS discovered a strong correlation between the ratio of foreign exchange turnover to trade and GDP per capita. That means that as a country grows economically and enters the realm of industrialized countries, its currency will experience exponential growth in turnover. For example, the British Pound and Japanese Yen are exchanged at a quantity that is 50 times greater than required for trading purposes. The ratio of forex turnover to trade for the US Dollar, meanwhile, exceeds ! The BIS was able to fit a regression line to the data that seemed to explain this phenomenon quite well. In fact, the line runs directly through the Euro, Hong Kong Dollar, Canadian Dollar, and Swedish Krona, and Norwegian Krona. There are also plenty of outliers. Turnover in the US Dollar, Japanese Yen, and Australian Dollar is almost twice as high as the model predicts. Perhaps the most flagrant outlier is the New Zealand Dollar, which seems to be traded at a frequency that is x higher than it should be. One interpretation of this analysis is that demand for the all of the currencies that fall above the regression line should decline over time, and should experience at least some depreciation. The opposite can be said for currencies that currently fall the regression line, especially if their economies continue to expand at a faster-than average pace. At the same time, it puts things into perspective. Even if demand for the Chinese Yuan doubled in accordance with the BIS model which would necessitate looser capital controls, among other thingsGDP per capital would need to increase 20x and US GDP per capita would need to remain constant in order for the Yuan to rival the Dollar in importance. Moreover, for a handful of reasons, it looks like China will continue allowing the RMB to appreciate at the same steady pace for the foreseeable future. And yet, the international community continue to use China as a scapegoat for all global economic ills, and are pressuring it to stop trying to control the Yuan altogether. If China was the only country to attempt to control its currency, perhaps the rest of the world would be willing to overlook it and write it off to ideological differences like they do with many of its protectionist economic policies. In the last week alone, South Korea, Malaysia, Singapore, and Thailand are all suspected of buying Dollars to hold down their respective currencies. Meanwhile, Brazil is enhancing its capital controls and Japan stands ready to intervene should the Yen spike again. It magnifies upward pressure on those emerging-market exchange rates that are allowed to move and where capital accounts are much more open. It intensifies inflation risk in those emerging economies with undervalued exchange rates. And, finally, it generates protectionist pressures. If any country appears to be taking these lessons to heart, however, it is China. To counter the inevitable upward pressure on the Yuan, it has taken such measures as prodding Chinese firms to look abroad for acquisition targets. Anecdotal reports show that manufacturers are unnerved by wage and raw materials inflation, and are uprooting factories. In the short-term, some of this production will move inland from the coast, but even this has its limits. I think Chinese policymakers recognize this, and I stand by my earlier prediction that the Yuan will maintain a steady pace of appreciation for the foreseeable future. Countries around the world have trading to criticize China for its unwillingness to allow the Yuan to appreciate. However, it was only when fellow emerging market economies — namely Brazil — voiced similar concerns, that China was finally forced to concede partial defeat. Still, China is not one to take its cues — especially on issues as important as the Yuan — from the international community. While it almost certainly gives the export sector a competitive advantage, it also deprives the PBOC of the ability to conduct monetary policy and is inherently inflationary. In addition to allowing the Yuan to slowly appreciate, China has also moved to make the Yuan more convertible. This has the dual advantages of making China less reliant on the US Dollar and on relieving upward pressure on the Yuan. More of its trade is being settled directly in Chinese Yuan. Chinese companies are being encouraged to invest outside of China, and foreign companies inside of China are gradually being permitted to issue Yuan-denominated bonds, rather than import Dollars to fund new investments. It appears that all of these measures are actually starting to have some impact. The IMF has suggested that the Chinese Yuan could one day be an international reserve currency and could be a component of its Special Drawing Rights SDR currency. Less hot money distinct from investment inflows is finding its way into China. Unfortunately, most analysts are skeptical that it will last. Futures markets reflect a modest 2. At the very end ofthe Chinese Yuan managed to cross the important psychological level of 6. Moreover, analysts are unanimous in their expectation that the Chinese Yuan will continue rising indisagreeing only on the extent. While American politicians chide it for not doing enough, the Chinese government nonetheless deserves some credit. Therein lies the problem. In the context of this discussion, however, that might be a moot point. Meanwhile, China is trying to slowly tilt the structure of its economy towards domestic consumption, which is increasing by almost every measure. Its Central Bank is also slowly hiking interest rates and raising the reserve requirements of banks in order to put the brakes on economic growth and rein in inflation. Finally, it is trying to encourage internationalization of the Yuan. There now 70, Chinese trade companies that are permitted to settle trades in Chinese Yuan. The average call, however, is for a continued, steady rise. If you take inflation into account, however, the Chinese Yuan has risen by much more. In fact, if current trends persist, the Chinese Yuan exchange rate controversy might resolve itself. Demands from the international community for China to appreciate its currency hinge on two related arguments. The first is that at its current level, the artificially low exchange has allowed China to build up a massive trade surplus. The second is that Chinese prices seem to be lower than they should be when quoted in other currenciesand the economic principle of Purchasing Power Parity PPP suggests that for this discrepancy to be eliminated, the Chinese Yuan must rise. As it turns out, both of these claims trading more problematic than they would appear. However, it turns out that majority of that surplus is being captured by foreign-funded companies: In addition, trade statistics are calculated in such a way that the country that assembles the finished product gets credit for the full export value of that product. As for inflation, the official rate is now 5. Even if we accept this and living in China, I can tell you that the actual rate is much, much higherthat means that the value of other currencies is eroding at a much faster rate than is implied by official exchange rates. The Chinese government is trying to address the problem in the form of price controls and mandated increases in supply, but it is still reluctant to rein in inflation using conventional monetary policy measures. As a result, the consensus among economists is that inflation will continue rising unabated: Unless circumstances change, then, the argument for further RMB appreciation is somewhat weak. Nonetheless, analysts remain optimistic: He explains that in order for this to happen, China would have to either run a large and continuous current account deficit, or foreign capital inflows into China would have to be matched by Chinese capital outflows. Simply, a reserve currency must necessarily offer foreign institutions ample opportunity to accumulate it. For this to change, foreigners would need to have both a reason and the opportunity to hold RMB assets. This would likewise an imply a Chinese government desire for greater foreign ownership. How likely is this to happen? According to Pettis, not very. In practice, this means that interest rates must remain low, and that there is little impetus behind the expansion of domestic consumption. Given that this has been the case for almost 30 years now, this could prove almost impossible to change. So there you have it. The implications for the US Dollar are clear. Instead, it has embarked on a campaign to further diversify its reserves, with important implications for the currency markets. Foreign investors are taking advantage of strong investment prospects, rising interest rates, and the guarantee of a more valuable currency. Since the Central Bank does not release precise data on the breakdown of its reserves, analysts can only guess. Still, China has stated transparently that it wants to diversify its reserves into emerging market currencies, following the global shift among private investors. Investment advisers praise China for its shrewdness, in this regard: If yuan look at the fundamentals of a lot of these emerging markets, they are considerably better than developed markets. Who wants to be holding U. When China recently signed an agreement with Turkey to conduct bilateral trade in Yuan and Lira following similar deals with Brazil and Russiait was interpreted as an intention snub to the US, since trade is currently conducted in US Dollars. In addition, by funding projects in other emerging markets through a combination of loans investments, China is able to curry favor with host countries, as well as to help its own economy at the same time. The second is financial: It is seen as an ally to financially troubled countries, while its efforts help to keep the Euro buoyant, relative to the RMB. For now, China remains deeply dependent on the US Dollar, and is still very vulnerable to a sudden depreciation it its value. For as much as it wants to diversify, the supply of Dollars and the liquidity with which they can be traded means that it will continue to hold the bulk of its reserves in Dollar-denominated assets. In addition, the Central Bank has no choice but to continue buying Dollars for as long as the RMB remains pegged to it. There are plenty of investors that think betting on China is trading close to a sure thing as there could possibly be. The Chinese government maintains strict capital controls, prohibits foreigners from directly owning certain types of investment vehicles, and prevents the Chinese Yuan from appreciating too quickly, if at all. For those that want exposure to China without all of the attendant risks, there is a neat alternative: In this case, there would appear to be a strong correlation between Chinese economic growth and the Australian Dollar. If the Chinese Yuan were able to float freely, it might rise and fall in line with the AUD. Since the Yuan is fixed to the US Dollar, however, we must look for a more roundabout connection. Before I get ahead of myself, I want to explain why one would even posit a connection between China and the Aussie in the first place. There are actually a few reasons. First, Australia is economically part of Asia: A further 15 per cent is with Southeast Asia. In fact, this presumed correlation has become so entrenched that any indication that China is trying to cool its own economy almost always prompts a reaction in the Aussie. Still, as long as the Chinese economy remains strong, the Australian Dollar should follow. The Aussie is also vulnerable to a decline in risk appetite, like the kind that took place during the financial crisis and flared up again as a result of the EU Sovereign debt crisis. During such periods, Chinese demand for commodities becomes irrelevant. As the Aussie closes in on parity and Australian exporters and tourism operators become more vocal about the impact on business, however, the Reserve Bank of Australia RBA might be forced to act. The Chinese Yuan has touched a new high, at 6. In fact, many analysts have argued that it is only because of the Yuan-Dollar peg itself, as well as the Chinese purchases of Yen assets that it engendered that Japan was forced to act: It should be noted that the two soundbites above both emanated from US Congressmen, which is important because the US government is currently mulling action on the Yuan currency peg. The Treasury will have an opportunity redeem itself in its next report on foreign exchange, due out on October 15, but it is expected that the report will either be delayed or released without adequately addressing the undervalued Yuan. In fact, Treasury Secretary Geithner testified before Congress last week, and at least admitted that something needed to be done: We have to figure out ways to change behavior. Despite the consensus among politicians and President Obama that the currency peg is harmful to the US economy, Geithner made it clear that the Treasury Department continues to favor unilateral action towards dealing with problem, without Congressional intervention. For now, then, politicians are probably relegated to saber-rattling and name-calling. In practice, China is likely to stick to its policy of gradual Yuan appreciation, or a few reasons. However, it is arguably just as dependent on forex US to buy its exports, which promotes employment and social stability, and it is keen to avoid a trade war if possible. If it wants to spur domestic consumption and promote more value-added manufacturing, it will need a more valuable currency. Also, if China has any serious ambitions of turning the Yuan into a global reserve currency, it will need to create capital markets that are deeper and more liquid, which it is currently unmotivated to do, lest it spur demand for Yuan by foreign institutional investors. Finally, China should let the Yuan appreciate because it is financially gainful to do so. As I mentioned above, its trade surplus with the US has widened over the last few years as prices for its exports grow along with quantity. Meanwhile, prices for imports and prices paid for commodities and other natural resources have declined in Yuan-terms. For that reason, I think China will probably continue to stick its current policy, and allow the RMB to continue to slowly inch up. The frequency of my reports on the Chinese Yuan is admittedly much higher than it used to be. Today, it stands only. On a trade-weighted basis, it is actually 2. What is going on?! It can foremost be attributed to a disconnect between Chinese words and Chinese action. On numerous occasions since supposedly allowing the RMB to appreciate, it has intervened in the forex markets through various shadow dealers to prevent this very outcome. In fact, China has increased its purchases of South Korean and Japanese sovereign debt, ostensibly as part of its diversification strategy, but more likely to put upward pressure on those currencies. That strong demand has been a key factor strengthening the yen in recent weeks. In fact, China can be seen moving backwards. Foreign governments, led by the US, are still threatening action. Senators and Congressmen continue to harp on the issue it is election season, after alland are still threatening to slap a tariff on all Chinese imports. I concluded my last post Euro Recovery: Two days later, I think I can offer an explanation: The force behind the sudden sea change might not be private investors, which up until the spike entrenched itself as a full-fledged connection, remained firmly behind the declining Euro. Instead, it seems quite reasonable that China — via its sovereign wealth fund, which is charged with investing its foreign exchange reserves — might be the responsible party. That China is buoying the Euro would make sense on a couple fronts. First of all, it would explain the mysterious silence behind the rally. China is naturally secretive in pretty much everything it does, especially in the way it conducts currency policy and manages its forex reserves. More importantly, that China is responsible also makes sense from a strategic standpoint. China has long spoken about its intentions to change the allocation of its forex reserve holdings, and in hindsight, its timing was perfect. In the beginning of June, the Euro stood at a multi-year low, and the price of US Treasury Bonds stood at a multi-year high. Moreover, China can achieve this diversification without influencing the value of the Yuan, since Dollars can be exchanged directly for Yen and Euros. That is important, since the RMB is still effectively pegged to the Dollar. On a trade-weighted basis, it has actually fallen. Pressure continues to mount on China to allow the RMB to appreciate. Due to pressure from China, however, it removed precise figures on the recommended extent of said revaluation. Instead, it has announced that it will make a more sincere effort to tie the Yuan to a basket of currencies, rather than just the Dollar. Going forward, then, the Yuan will probably remain basically stable against the Dollar. As China moves towards a trade-weighted peg, however, it is conceivable that it will continue to buy Euros and Yen, for spite against the Dollar. As this could have a confounding effect on currency markets, traders should plan accordingly. After the initial excitement faded, a sense of disappointment set in as it became clear that China had no intention of allowing the RMB to appreciate rapidly: Due both to its slow speed and small scope, the revaluation could conceivably benefit the Chinese economy. The quantity of exports is unlikely to decline, such that total export revenues could actually increase. Maybe in 10 years, importers will have a choice, but right now they will just have to pay more. No other country…can build a manufacturing base and all the infrastructure that you need — transportation, energy, the entire value chain to the final good — takes many years. As a result, American manufacturers and other vested interests have announced that they will continue to lobby the US government to pressure China on the currency issue, on the basis that the undervalued RMB is eroding both the US economy and the labor market. According to analysts, however, political infighting make it unlikely that any new law or punitive tariffs will be imposed anytime soon. At the very least, China will continue to make the Yuan more flexible, so that one day it can float freely. As for the impact on the rest of the forex market, I think that commodity currencies and growth currencies could come out ahead. The move signals an implicit confidence in the global economic recovery and can perhaps be seen as a harbinger for high commodity prices: This trend will probably continue, since smaller purchases of Dollars will be required to maintain the floating peg. But that is a topic for another day…. My suspicions were confirmed on Monday, when the markets opened, and the RMB jumped by a pathetic. Most commentators shared my cynicism about the move. The timing of it is clearly aimed at the G meeting, which indirectly links to the whole renewed thrust in Congress with protectionist steps against China. It is neither freely floating nor is it pegged to a basket of currencies in which case it could conceivably appreciate faster against the Dollar, due to the weak Euro. It is technically allowed to rise and fall on a daily basis within a. If the rate fluctuates too much, state-owned companies often intervene in the markets at the behest of the Central Bank. Not that it matters. In the US, where it is legal to make long-term bets on the RMB via futures contractsinvestors are still only projecting a 1. To be sure, there is a possibility that the RMB will be allowed to steadily appreciate, in which case there would be real implications for other financial markets. If the past is any consideration, however, the RMB will rise only modestly against the Dollar, and even more modestly on a trade-weighted basis. Its economy will remain overheated and imbalanced, and if it was headed towards collapse prior to this latest change, it certainly still is. As replacement s for the Euro are sought, such long-held assumptions are being challenged. The Chinese Yuan is attractive for a number of reasons. Finally, the widespread consensus is that the RMB will appreciate anyway, so holding it seems like a safe bet. The bet is that holding yuan-denominated assets is an important feature of a diversified national reserve. Still, these are small-scale agreements, and Central Banks are really just testing the waters. Simply, there are not enough liquid, attractive investments, denominated in RMB. Buying Chinese government bonds seems like a safe option, but given, that China finances most of its spending with cash, such bonds are not widely available. For now, the Chinese Yuan will remain most attractive from the standpoint of a reserve currency to regional trade partners, because such countries have a genuine use for RMB. Investors seem to understand this idea, and are using the currencies of such countries to bet indirectly on the RMB. The Malaysian ringgit, Taiwanese dollar and Korean won are also high on the list of currencies affected by the yuan. It will probably be at least a decade before holding the Yuan is as viable not to say attractive as the Japanese Yen. Regardless of how it ultimately plays out, though, the bailout not too mention the concomitant crisis is shaping up to be THE big market mover of As investors reposition their chips, some early front-runners are emerging. It might surprise you that one such leader is the Japanese Yen. On the surface, the Japanese Yen would seem to be an excellent candidate for shorting, especially in the context of the the Greek fiscal crisis. First of all, with confidence in the Euro flagging, the Yen and the Dollar gain luster as the only viable reserve currencies. Second, the current consensus is that the Euro bailout will fail, and as a result, risk tolerance is running low at the moment. Analysts have been quick to point out that the rest of Asia among other regions are on the other side of this trend. China could be hit especially hard. Of course, if the plan turns out to be a success, than the opposite will probably obtain. Interesting, the rate of reserve accumulation has slowed markedly from There are a couple key explanations for this slowing. Second, China tallies its reserve growth on a net basis — after accounting for changes in valuation. With this in fact in mind, the actual slowdown is probably much less pronounced than the numbers would suggest. Besides, exports and foreign direct investment both continue to grow at healthy clips, which means there is nothing barring a revaluation of the RMB which could significantly slow reserve accumulation going forward. Even with a revaluation that many experts believe is imminentthe need to further accumulate reserves will not be impacted, because the RMB will certainly continue to be pegged to the US Dollar. In order to prevent price inflation which is already creeping up from reaching dangerously high levels, then, the government will have no choice but to continue to soak up all capital inflows for as long as the RMB remains pegged. Since the Chinese RMB is also pegged to the Dollar, that means that as the RMB appreciates against the Dollar, the value of its reserves will fall in local currency terms. Rectifying this problem is basically impossible, as the EU sovereign debt crisis has demonstrated. For all of the problems with the Dollar, the alternatives are just as bad, if not worse. While a handful of commentators saw this as a simple quid pro quo, the consensus among most of us is that a revaluation of the Chinese Yuan is now imminent. Technically, the RMB has been rising steadily for the last few months, and in fact, it recently touched a 9-month high against the USD. However, this appreciation has amounted to a mere. On the surface, it looks like President Obama deserves much of the credit for the sudden capitulation by China. From tire tariffs to a meeting with the Dalai Lama, he signaled that he was willing to play hard ball. But years of experience have shown that the Chinese will not be moved by words; they only respond to tough action. While this game of high-stakes International Poker was being played, there was an internal debate taking place within China. On one side forex the Central Bank, frustrated by its inability to conduct monetary policy independent of the currency peg. On the other side was the more powerful Commerce Ministry, which is responsible for representing the interests of Chinese exporters, among others. At this point, analysts have stopped arguing about whether the revaluation is necessary though this debate has not officially been resolved and moved on to simply trying to predict the outcome of the internal Chinese negotiations. Asian currencies should also benefit, since a more expensive Yuan will trigger a marginal shift of speculative capital to regional competitors, especially those with undervalued currencies. I like to think of it as a rudimentary form of hedging. Over the last couple weeks, rising expectations of a resumed appreciation of the Chinese Yuan RMB have brought heightened tension. Politicians, economists, and even newspaper columnists are finding themselves involved in increasingly bitter disputes over the issue. Breaking with his old strategy on multiple fronts, it should be noted of soft speech and appeasement, President Obama is now openly calling on China to allow the RMB to appreciate: Countries with external surpluses need to boost consumption and domestic demand. Meanwhile, the US Treasury Department is busy preparing its semi-annual report on foreign currencies, which will be presented to the US Congress on April As usual, the media is focused on the portion concerning China, specifically with whether it is officially labelled a currency manipulator. Almost by definition, China manipulates the Yuan, but the Treasury Department has heretofore avoided the label because it would allow Congress to impose punitive trade sanctions. Ironically, the most pressure to bestow such a label is coming from Congress, itself. Aside from the report, Congress is not sitting by idly, as evidenced by a recent letter to the President signed by Representatives calling for action. The only way we will change them is by forcing them to change. Chinese government officials continue to send conflicting signals. At this point, everyone — except for Stephen Roach and the WSJ editorial board — seems to agree that a revaluation would benefit everyone. Chinese officials accept and even share that view, and from their point of view, the revaluation is only a matter of being able to do so on their own terms. At that time, it was projected that that Yuan would finish at 6. The answer is a combination of economics and politics. In addition, if the Central Bank of China raises interest rates to counter property speculation, it will have even less room to maneuver in its forex policy if it wishes to maintain high GDP growth. On the other hand, China still desires to turn the Yuan into a global reserve currency, again both for economic and political reasons. In order to accomplish such a feat, one of the prerequisites would be dual convertibility. Recently, there was a perception that China had begun to diversify its reserves out of Dollars, as US Treasury data indicated that its Treasury purchases had all but stopped. As it turned out, China had merely moved to conceal its purchases by conducting them through a UK Bank. The biggest threat to the USD posed by China is not an end to the RMB peg — for such is unlikely — but rather a change in its structure. Currently, the RMB is pegged directly to the Dollar, which means that the Bank of China MUST stockpile its trade yuan in USD-denominated assets, namely US Treasury securities. If the peg were to shifted to a basket of currencies, however, it would have more flexibility in the denomination of its reserves. On the one hand, the case for RMB revaluation is stronger than ever. From an economic standpoint, then, the case for an artificially cheap currency is no longer easy to make. At the same time, the RMB peg is contributing to bubbles in property and other asset markets. Thus, consumer prices are slowly creeping up, and property prices are soaring. The most effective and perhaps the only way for China to contain both consumer price and asset price inflation is to hike interest rates, which which in turn, would necessitate a rise in the RMB. There is also the notion that the peg is becoming increasingly costly to maintain. The solution to both of these problems, of course, would simply be to allow the Yuan to fluctuate based on market forces, or at least for it to resume its upward path of appreciation. Political pressure on China to revalue, meanwhile, is even stronger than it was last month. While not invoking China by name, President Obama has been increasingly blunt about the need to pressure it on the RMB: More importantly, the leadership is nervous that the nascent economic recovery is not sufficiently grounded for the peg to be loosened. There you have it. Reason on one side, and politics on the other. Unfortunately, it seems that politics always triumphs in the end. Foreign pressure is only a secondary consideration. The Chinese Yuan RMB spent all of pegged to the Dollar at 6. Since the Dollar depreciated against almost every other currency during that time period, the Yuan has fallen against these currencies, undoing most of its appreciation in The only questions are whenhow and to what extent. In hindsight, the Central Bank i. At a time when forex markets and other capital markets, for that matter were behaving erratically, the Yuan was a baston of stability. The result was price stability, and a boost to exporters that had been damaged by the falloff in foreign demand for Chinese goods. With the global economy emerging from recession, the argument for maintaining the peg is becoming less tenable. It has been approximated at 2. The dual concerns, of course, are that the money supply is expanding too fast and that bubbles are forming in certain asset markets. The weak RMB is certainly not helping either. Holding down the Yuan in the face of such pressure is becoming prohibitivel expensive: There is also the argument, much mooted in economics circles, that an appreciation of the RMB would be good for the Chinese economy. Because of a perennially weak currency, its economy has become to addicted to exports to drive growth. Skeptics of the usefulnes of RMB appreciation point out that rebalancing the Chinese economy would start with changing the culture of saving, but a stronger currency would certainly provide a powerful incentive. On the other side of the debate are skeptics of a different sort- those that think RMB appreciation is justified by forward-looking macroeconomic fundamentals. Some fear hyperinflation of the sort that China faced in and was only brought under control by the global economic recession and concomitant decline in resource prices. In a hyperinflation scenario, the Central Bank might even have to deliberately depreciate the currency. Then there are the skeptics that forecast an economic crash in China. While this view is gaining some traction, it is still relegated to the minority. Investors and economists are now operating under the firm assumption that China will allow the RMB to resume its appreciation soon. As for whenit could be any day, though probably not for a few months still. Most analysts, though, expect the rise to be gradual. It also depends on how the Dollar performs over the near-term: Investors are erring on the side of appreciation, however, and futures prices reflect a 3. This disconnect is indicative of the fact that there is both a political and an economic side to this issue. More specifically, a chorus trading economists backed by hard data is arguing that the RMB is one of the foremost causes of the widening imbalances. Meanwhile, while GDP is projected at Foreign capital is now pouring into China at a record pace — largely in anticipation of an imminent appreciation in the Yuan — such that asset prices have almost doubled over the last year. Echoed the head of the IMF: Foreign politicians, especially those from the US, have been hammering these points home. President Obama made the RMB a key issue during his visit to China this week. Other Chinese Ministers rebuffed reporters in separate sessions who even dared to bring up the RMB: The Central Bank recently changed some of the language which governs its forex policy; going forward, the Yuan will apparently be tied to a basket of currencies, with its value also influenced by trends in capital flows. As I indicated above, investors are cautiously optimistic that the government will eventually relent to its critics and allow the currency to resume its steady upward path. Futures prices have risen steadily since September, when they reflected a flat RMB over the next twelve months. Personally, my money is an appreciation in the near-term, as soon as the first quarter of As the title suggests, the article described the increasing interdependency between the economies of the US and China. In a forex, China maintains an undervalued currency, in order to stimulate exports. The resulting overseas American demand puts upward pressure on the RMB, which China defuses by buying US Treasury securities. This results in artificially low US interest rates, causing American consumers to import more, putting even more pressure on the RMB, which is further defused by buying more US Treasuries. And the cycle continues ad nauseum. The article focused primarily on the political side of this precarious relationship, at the expense of the financial implications. It got me thinking about the forex forces at work, and how a disruption in the cycle could have tremendous ramifications for currency markets. Given the depreciation of the Dollar over the last six months, this seems almost hard to believe. Over the same time period, though, China as well as many other Central Banks have vastly increased their Treasury holdings. But as China responds by plowing all of those Dollars back into the US, then the net effect is zero. As the Economist article intimated, there are a couple of developments that would seem to upset this equilibrium. The first would be if the Central Bank of China began diversifying its forex reserves into other currencies. By definition, however, it would be impossible for China to continue pegging the RMB to the Dollar without simultaneously buying Dollars. Thus, the day that China stops recycling its export proceeds into the US, the RMB would start to appreciate, almost instantaneously. In addition, the sudden surcease in US Treasury bond purchases would cause interest rates to rise. Both higher rates and a more expensive currency would presumably result in lower demand for Chinese exports, and hence eliminate some of the need to recycle its trade surplus back into the US. The sooner it stops purchasing them, the sooner it will no longer need to purchase them. China must recognize the dilemma that it faces, which is why it refuses to break from the status quo. If it allows the Yuan to appreciate, it will naturally face a decline in exports AND the relative value of its US Treasury holdings will decline in RMB terms. Both would be painful in the short-run. With every passing day, the adjustment will only become more painful. In its semi-annual report to Congress, the Treasury Department once again failed to officially label China or any country for that matter a currency manipulator. Other countries have also begun to raise concerns about Chinese dumping, and bringing their cases to the WTO for good measure. Many of these countries are in fact suffering more than the US. Since the Yuan is effectively pegged to the Dollar, the decline of the latter has been mirrored by the former. Since many other currencies of developing countries are also fixed, this leaves only a handful to absorb the shock. The handful of floating currencies in the regionsuch as the Korean Won, Indian Rupee, Malaysian Ringhit, etc. For them, it is not so much the weak Dollar that they fear so much as the weak RMB, since China is a direct competitor to all of them. The Nationalist camp, for example, is pressing for China to make the Yuan a more prominent currency on the international trade scene. The other group pushing for a stronger Yuan is doing so on more fundamental, economic grounds. Just-released Q2 GDP data showed prelimenary growth estimates of a whopping 8. Not bad, especially when you consider that the rest of the world remains mired in recession. Chinese economists largely ignore the political implications of the notion that this growth probably came at the expense of the rest of the world, and focus instead on the economc implications. First is that the economy remains hopeless dependent on exports to drive growth, which can only be remedid through a stronger Yuan. Second, it heralds the coming of inflation. My bet is that this will be kicked off by another one-off appreciation, in the same vein as July Now as was the case then, China needs to make up for lost time. As it turns out, the last few days have witnessed a few developments on this front. First of all, the G7 concluded its latest round of talks. Despite previous indications to the contrary, the organization continued its practice of releasing a communique. One columnist connects the dots with regard to the forex implications: In fact, China is fully on board with this notion. Following the G7 talks, Chinese officials announced that it would support a stronger Yuan as soon as the global economic crisis resolved itself. By its own reckoning, this would facilitate a shift in its economy, from one dependent on exports for growth to one focused around domestic consumption. Speaking of China, it is also among the most vocal of nations laboring for alternatives to the Dollar. Towards this end, it has reportedly formed a secret coalition with the other BRIC countries Brazil, India, and Russiaas well as Japan. The goal is to end the pricing of oil in Dollars by That the group has given itself nine years to complete this task speaks to its extraordinary ambition. The implications for the Dollar cannot be understated. Already, the government of Iran has mandated that in the future, all of its reserves be held in non-Dollar-denominated assets. Thus far, no other countries have followed suit. China is aware that pushing for further developments could roil the US, which would be unlikely to sit on the sidelines and watch its currency be summarily jettisoned. But the circumstantial evidence — official buying of U. So, forex you have it. It may have already begun…. By now, the notion that the nascent global economic recovery is being and will continue to be led by China has become cliche. The NY Times summarized: But for the first time, the catalyst is coming from China and the rest of Asia, where resurgent economies are helping the still-shaky West recover from the deepest recession since World War II. The statistics are certainly compelling. After a brief dip in the first quarter, GDP grew by an impressive 7. In hindsight, the downturn in Chinese economic output was so slight as to hardly warrant use of the term recession to describe it; any other country would have rejoiced after achieving 6. While stock market investors are evidently optimistic that the economy will continue to gather momentum, China-watchers and policymakers are more cautious. We cannot be blindly optimistic. Net new lending in July was In addition, the stimulus itself was not necessarily geared towards sustainable growth in trading economic, not the environmental sense. Over the last two decades, China embraced an economic model focused around exports and capital investments, at the expense of domestic consumption. Chinese capital spending could exceed that in America for the first forex, while its consumer spending will be only one-sixth as large. To be sure, the government has rolled out incentives and subsidies designed to reduce savings and increase consumption. For better or worse, the global economic downturn has severely crimped demand for Chinese exports, and this component of GDP could remain depressed for quite some time. The currency has essentially been fixed at 6. Given the decline in the trade balance and the explosion in the budget deficit, however, much of this increase must be attributed to the inflow of speculative capital, which will not necessarily translate into currency appreciation. While the spot exchange rate has risen to the strongest level since May, futures prices indicate a modest 1. This is an improvement from expectations of a flat exchange rate, but still a long way away from what some economists think is reasonable. As far as currency traders are concerned, this development has two important implications, the first of which concerns the Chinese Yuan also known as RenMinBi or RMB. But the latest analysis suggests that when push comes to shove, China is still firmly behind the Dollar: This mix has been relatively stable as the Chinese government continues to place the bulk of its reserves in U. While other Central Banks are gradually paring their holdings of US Treasuries, China is adding to its own stockpile. Treasuries, it is a diversified portfolio overall. Zhou, who only a couple months ago was leading the charge for a global reserve currency. Perhaps over the longer-term, it can begin to take steps to dislodge the Dollar, but for now, it appears that China has accepted the status quo. For other hard commodities, the cost of storage is high and prices fluctuate wildly. China did recently appoint a new official an economist trained in the US to manage its reserves. Still, I think that the Yuan will continue to appreciate slowly and steadily, because such is in the best interest of China. The reason China has been able to get away with holding the Yuan constant for such a long period of time is the collapse in its trade surplus. As a result, the Central Bank can now have its cake and eat it to, by holding the Yuan constant without worrying about the effect on prices. The most recent forecasts, however, suggest this is about to change. If such growth materializes, this would place China in a dilemma, such that it would have to choose yuan higher prices or more expensive currency. Economics aside, there is another major reason why the Yuan should continue to appreciate. Still, the currency is still nowhere near satisfying the requisite convertibility inherent in reserve currencies. A reserve currency also requires a deep and liquid bond market, free from government interference. Still, China deserves credit for their resolve on forcing the issue, as well as for providing an alternative to the Dollar monopoly. The Head of the World Bank, Robert Zoellickagreed: Conspiracies aside, the Chinese Yuan will become a reserve currency when it is ready to become a reserve currency. Simply, investors and Central Banks buying Yuan would not want to simply invest in paper currency; instead they would want stocks and bonds that trade transparently. If China wants the Yuan to be a serious contender with the Dollar, it needs to give investors more and better options. According to a recent Reuters pollinvestors are increasingly bullish on emerging market Asian currencies, including the Taiwan dollar, Indonesian rupiah, Singapore dollar, Malaysian ringgit, Philippine peso, South Korean won, and Indian rupee. Leading the pack are the Taiwan Dollar and South Korean Won, which recently touched five-month and seven-month highs, respectively. Investors are now pouring money back into Asia at rapid clip. One commentator summarized this contradiction as follows: Investors are going out of dollars to riskier markets, riskier currencies. The only bright spot economically is Taiwan, which is benefiting both from improved economic ties with China and a healthy current account surplus. As a result, this rally could soon begin to lose steam. In short, these currencies and other investments will continue to find buyers for as long as there are those hungry for risk. A representative of the firm declared: The news initially sent a ripple through forex and commodities markets, which were overwhelmed by the figures involved. After analysts had a chance to gather some perspective, however, the markets relaxed. You see, although the increase seems tremendous in size, it is quite small in relative terms. It is relatively small compared to other countries: It is relatively small given the six-year duration of accumulation: On some level, the development has at least some symbolic importance, as it demonstrates that it cannot be taken for granted that China will simply continue to plow its dwindling trade surplus into Dollar-denominated securities, or even currencies in general. The announcement also explains the recent buoyancy of gold prices. Historically, there existed an inverse correlation between gold and the Dollar. This correlation has all but broken down as a result of the credit crisis, and for the first time a strong Dollar has been accompanied by high gold prices. Part of the reason may be increased buying activity by Central Banks, including the Bank of China: Considering that Treasury Secretary Geithner accused China unequivocally of currency manipulation during his confirmation hearing in January, it would seem that an official condemnation was inevitable. Alas, the report once again exonerated China: Second, the Chinese currency appreciated by Even so, Treasury remains of the view that the renminbi is undervalued. There was certainly a political calculus that went into the decision. There is also mounting economic evidence that China is no longer manipulating the Yuan, at least not to the same extent as before. This can be explained as follows: The Chinese money supply expanded by a record Having appealed unsuccessfully to the G20 to create a viable reserve currency, China is now taking matters into its own hands, by pushing the Chinese Yuan as a viable alternative. The agreement is ostensibly designed to benefit Argentina, whose economy has been hit hard from the global credit crisis: In actuality, the swap was probably proposed by China in order to demonstrate its sincerity in seeing the Dollar replaced as reserve currency. China is also moving to make the Yuan fully convertible, such that it can be exchanged freely both inside and outside China. It is intended that Chinese banks and exporters, for example, will now be able to accept payment directly in foreign currencies, rather than first being forced to convert them into RMB. A recent note by Citigroup analysts perfectly encapsulates this sentiment: While the internationalization of CNY has a very long way to go, we see China as using the global crisis as an opportunity to take early steps. In hindsight, it seems that the announcement was a political ploy, rather than a harbinger for a policy change. Treasury holdings, it forex scarcely be able to dump that in large blocks. Investments in other currencies and markets, meanwhile, probably would have yielded similarly poor returns. At that time, China began to sell long-term government debt. Given that this is probably many years away, however, it has little choice but to continue to hold Treasuries and the like. In the words of a high-ranking Chinese official: One Dollar trades for approximately 6. Futures pricesmeanwhile, reflect a mean expectation that one year from now, the exchange rate will dip only slightly, to 6. In fact, there is even evidence that China is fighting market forces by trying to prop up the value of the Yuan. Within China, there is a core group of academics that continues to insist that China should depreciate its currency in response to deteriorating economic conditions. This has made Chinese exports relatively less competitive while spurring more imports and thereby providing somewhat of a boost to other economies. US Treasury yields have been held low across the short-term and long-term due in part to a lack of appealing investment opportunities in a deflationary period, while the Federal Reserve announced in January the possibility of buying long-term US government Treasury bonds to help hold down long-term interest rates and thus mortgage rateshoping for a slow controlled decent in housing prices. At the other end of the spectrum, the US government has been bailing out every large financial institution willing to accept a few billion here or there, and running the printing presses in overdrive. Eventually this will lead to inflationas explained by John Williams last August:. Excess supply of a commodity or product usually is reflected in downside pressure on its price, and the same is true for money. Excessive supply of money leads to its debasement, to a decline in its value that otherwise is known as inflation. Where money supply generally is an underpinning of economic activity, it also is the ultimate determinant of prices and inflation. At present, near-record high annual growth in the broadest U. Seeing their own economy slow, and the coming risk of inflation, the Chinese government is looking to shift some of their reserves away from US Dollars to hard commodities, particularly oil. China is considering plans to tap its foreign reserves to buy crude oil as part of a push to diversify holdings from U. Treasurys, according to a published report. China, which has been building up a national oil stockpile sinceaims to amass million barrels by next year as a first step, the Japanese business daily Nikkei reported. After nearly six months of currency depreciation, the nations of Asia have finally been spurred to action. The goal is to prevent capital flight and currency weakness from engendering the same kind of financial crisis that only 10 years ago ravaged Asia. Ironically, the bulk of these reserves belong to China and Japan who are also funding a large portion of the forex poolboth of whose currencies remain strong in spite of the crisis. While China remains committed, in rhetoric at least, to a flexible Chinese Yuan that rises and falls in accordance with market forces, its actions suggest otherwise. Beginning in the second half ofChina stopped allowing the Yuan to appreciate, for fear that a more expensive currency would exacerbate the domestic effects of the credit crisis by making exports less competitive. What China fails to realize however, is that a more valuable Yuan is not only conducive to global economic stability, but also to its own economic well-being. In fact, the artificially cheap Yuan may have actually worsened the economic downturn in China, because de-incentivized the creation of a domestic economic base. Now that overseas demand has dried up, it is left feeling the consequences of this neglect. The San Francisco Chronicle reports:. Undervalued currency helps, hurts U. Speculation surrounding the Chinese Yuan has been mounting for months, beginning with a sudden halt to the currency's appreciation and continuing with the insinuation of the Obama administration that China is a currency manipulator. In the context of falling exports and a sagging economy, meanwhile, the Chinese Ministry of Finance has issued a research report encouraging the Central Bank to allow the currency to appreciate. Despite the Central Bank's insistence that it wants a "stable" currency, futures prices indicate a mean expectation that in fact, the Yuan will be nudged downward over the next twelve months. On the other side of the equation are financial analysts, who collectively forecast a slightly stronger Yuan, with one bullish analyst projecting a 3. The recent data challenges both views. Lending looks good, money supply looks good, and the PMI balanced to slightly bad from very bad levels. Citigroup Is Bullish on Yuan, Bets for 6. Unfortunately, the administration does not exactly have support from political and economic analysts. So-called hot money may flee, global companies may repatriate profits and Chinese savers might buy overseas assets. China Tells Obama What to Do With His Yuan Views. During his confirmation hearings, Treasury Secretary Geithner indicated that the Obama administration consensus is that China is manipulating the Yuan. China predictably refuted the charges, and indicated that it will not be bullied into submission by the US when managing its currency. Thus began a heated back-and-forth between US and Chinese economic officials, with the forex markets caught awkwardly in the middle. Geithner apparently doesn't realize that his position also carries important diplomatic responsibilities, namely helping the US government to pay its bills by ensuring a steady demand for US Treasury securities abroad. The implications for the Dollar couldn't be clearer. China has been a major purchaser of America's official debt in recent years. If it were to stop…Geithner would likely find his Treasury paper having to offer higher yields to draw investors, putting new pressure on the American budget. While much has been written about the forex implications of the Barack Obama Presidency, most of the commentary has focused on the Dollar, at the expense of reporting on other currencies. The Chinese Yuan, to name one such currency, could soon find its fate tied closely to Obama; it has been widely speculated that he will compensate for the reticence of his predecessor by formally labeling China a currency manipulator and pressuring its to allow the RMB to appreciate at a faster pace. Timothy Geithner, who is set to be confirmed as the next Treasury Secretary, has echoed similar sentiments. In fact, China itself has every reason to avoid both depreciation and appreciation of its currency. The latter could further weigh on already drooping exports, and the former could lead to capital outflows from the country, at a time it can least afford this. Investors await Obama's signals on China's yuan. Anyone curious about whether China is intentionally allowing the RMB to depreciate, need look no further than the Central Bank's latest forex reserve figures, which registered a decline for the first time in nearly six years. At the same time, Chinese trade figures indicate that exports fell for the first time in seven years, which limits the government's ability to build up new reserves. As a result of the credit crisis, it's conceivable that the Central Bank will continue to spend down its reserves in order to provide a boost to its faltering economy. US President-elect Obama will have to deal with such forces if he wishes to successfully take on China's currency policy. China's forex reserves fall. Only a few weeks ago, investors had made significant bets that China would reverse its official policy of RMB appreciation. Since then, however, the RMB recorded its biggest one-day rise since the currency peg was abandoned three years ago, and investors subsequently scaled back their bets. While it's unclear what caused the sudden change in sentiment, there are a few factors which probably contributed. First is Treasury Secretary Henry Paulson's recent visit to China, in which he encouraged China to continue to permit the the Yuan to appreciate. In addition, high-ranking Chinese economic policy-makers have indicated that market forces will increasingly determine the valuation of the Yuan. Finally, there is the recent election of Barack Obama, a long-standing critic of what he believes to be the undervalued RMB. Yuan Forwards Advance Most Since Peg as China Seeks Stability. When all is said and done, the US government will have injected trillions of dollars into the economy, in the form of bailouts, guarantees, economic stimuli, etc. Whether it will have the desired effect is debatable. China's economy remains heavily reliant on the export sector to drive growth. Because its exchange rate regime does notpermit the RMB to fluctuate freely, the proceeds from the consequent trade surplus must be invested abroad, rather than domestically. For both symbolic and economic reasons, it seems the bulk of the surplus will continue to be invested in the US, probably in safer assets like US Treasury Securities. This is certainly good news for deficit hawks and Dollar bulls. The Wall Street Journal reports:. Even if China wanted to invest outside the U. If China recycled its foreign currency into, for instance, the European Union or Japan, it would effectively force those trading partners to run large trade deficits with China, which neither can absorb. China Will Keep Buying U. Since China revalued the Yuan in Julyit was considered a foregone conclusion that the currency would continue appreciating at a steady clip. The global credit crisis, generally, and the Chinese economic downturn, specifically, has turned that assumption on its head. Last week, the RMB declined by the biggest margin since the revaluation, prompting speculation that China will adopt a currency policy diametrically opposed to that which it has pursued over the last few years. The move also coincided with the annual China-US trade summit, attended by none other than Treasury Secretary Henry Paulson. The new consensus among currency traders proxied by futures contracts is that the Yuan will depreciate slightly over the next two years, as China moves to provide a boost to its export sector. Such a move would go against the realities of geopolitics and against signals that Beijing is more focused on boosting domestic consumption than on stimulating exports. Will China Finally Try Wielding Its Yuan? At the same time, the US exports sector- previously one of the few bright spots of the sagging economy- has begun to stall. US Politicians have taken note, and are now renewing their efforts to persuade China to allow its currency to rise further. Meanwhile, the Chinese economy is growing at the slowest pace in years, and the Chinese government is resorting to desperate measures to prop it up. In short, allowing the RMB to rise, while placating US policymakers, is tantamount to economic suicide, and hence unlikely. While other sovereign wealth funds have existed for nearly 50 years without controversy, "China appears far less likely than other nations to manage its sovereign wealth funds without regard to political influence that it can gain by offering such sizable investments. US panel urges action on China currency, investing. Last week, China revealed that in the most recent quarter, its economy grew at the slowest pace in nearly five years. How can this seeming contradiction in economic peformance be reconciled? In my opinion, the Chinese economy will continue to slow as a result of a generalized post-olympics slowdown and falling export demand brought on by the global economic crisis. The consequent collapse in risk appetite will bear negatively on investing in Chinese assets. In other words, there will be less foreign capital for the Central Bank to soak up, and less pressure on the RMB to appreciate. The various factors at play could actually be causing some capital outflows as troubled foreign firms and investors may need the money overseas. The New York Times reports:. China finds itself hemmed in. If it were to curtail its yuan of dollar-denominated securities drastically, the dollar would likely fall and American interest rates could soar. Main Bank of China Is in Need of Capital. Apparently, in an ostensible effort to clamp down on inflation, the Central Bank of China is resorting to draconian measures. One rule change, which was executed with both speed and lack of media coverage, requires commercial banks to hold a larger portion of their reserves in Dollars, rather than Chinese Yuan. In addition, such banks face new restrictions on foreign debt, which is designed to turn them into net buyers of Dollars. Analysts suggest that this policy represents a roundabout attempt to slow the appreciation of the Chinese Yuan. If they are correct, than surely the Central Bank of China has succeeded, for the currency has virtually ceased in its interminable upward march against the Dollar. This upshot suggests that the goal of the Central Bank was not to fight inflation, but rather to avoid a post-Olympic economic slowdown. They are now more worried about growth than overheating, and you are seeing that play out in the currency markets. There has been a remarkable change of view. Beijing swells dollar reserves through stealth. Almost all of the speculation surrounding the Chinese Yuan is aimed at predicting the point at which the currency will stop rising. Will it stop at 6. But what if the currency has already peaked, at least temporarily? Accordingly, it will probably relax interest rates and slow the appreciation of the currency, in order to give businesses and exporters the leverage they need to keep the economy going. Such measures are likely to further stoke the fires of inflation, at a time when prices are already rising at the fastest pace in a decade. The futures markets have been quick to take note, and expectations for Yuan appreciation are falling accordingly. Two weeks ago the contracts, predicted an advance of 5. At the start of last month, they priced in a 6 percent rise. Dollar Bottom Against Yuan Gets Louder in China Bet. As the Chinese Yuan has appreciated over the last three years, and even in the decade leading up to the sudden revaluation, a tremendous amount of speculative "hot money" poured into China. Periodically, the government and Central bank have attempted to stem some of these inflows by creating deliberately unfavorable conditions for foreigners to invest in China. Witness the unnaturally low interest rates and the one-way convertibility of the Chinese Yuan. Now, with inflation running at a year high, the government is becoming more serious in its efforts to clamp down on some of the factors that are driving demand. As a result, it altered its system for governing forex and will increase its oversight over the entities and businesses that import capital into China. If executed properly, much of the upward pressure on prices, and the RMB itself, could be relieved. China operates "a managed float exchange rate system based on supply and demand". Yesterday, the Forex Blog forex that Central Banks and Sovereign Wealth Funds appear to be losing confidence in the Dollar. To follow up with a specific example, a high-ranking Chinese policymaker recently suggested that China should move spend some of its reserves since they are rapidly losing value in RMB terms. The official offered that a portion be used to purchase foreign energy assets, in order to mitigate against both the falling Dollar and rising oil. There is clearly a trend among institutional holders of Dollars to use the currency to purchase US assets. Witness the recent separate sales of the Chrysler and GM Buildings to Middle Eastern buyers. China Considering Using Forex Reserves. In the year-to-date, the Chinese Yuan has already appreciated 6. This upward pressure has been built largely on the continuing inflow of speculative "hot money," which was itself built on the expectation of further interest rate hikes, ostensibly needed to tame inflation. However, the Central Bank of China recently indicated a slight shift in its monetary policy, backing away from fighting inflation in favor of promoting economic growth. At least until after the Olympic Games conclude, China will henceforth ignore inflation, so as not to precipitate a slowdown that could jeopardize the Games. Once the Olympics are out of the way, the vigil yuan inflation may have to resume. But unless China gets flooded by speculative flows, a one-shot revaluation will remain off the table. Ironically, some analysts believe this may be a harbinger for a faster appreciation of the Chinese Yuan. While the global credit crisis cannot be completely disentangled from the Chinese macroeconomic picture, certain conclusions can be drawn that are specific to China. In a nutshell, the party may be over. Inflation has surged to a year high, economic growth is slowing, and stocks are facing a prolonged bear market. The Chinese government will likely continue to bide its time so as not to disrupt the Olympics. After the conclusion of the games, however, the Central Bank may begin aggressively hiking rates in order to tame inflation. While this would adversely affect economic growth, it would cause the Trading to appreciate. China Bulls Get Shanghaied. Over the following 18 months, however, analysts yawned as the reserves nearly doubled in size. By no coincidence, this news caused the highest daily appreciation in the Chinese Yuan in more than three months. China has allowed a 2. In its semiannual report to Congress, the US Treasury Department once again did not cite China as a forex manipulator. For as long as the Forex Blog has been covering this issue, various interest groups have been pressing the Bush administration on this issue, since the label of currency manipulator would entitle Congress to level punitive trade sanctions. The Treasury Department, under the leadership of Henry Paulson, insists that the best way to handle the situation is through dialog. However, with the Presidential election looming, the RMB could become a major political issue. Already, both Hilary Clinton and Barack Obama have announced their intention to co-sponsor a bill that would impose trade sanctions on countries i. China that are deemed to undervalue their currency. US declines to cite China as a currency manipulator. The anecdotal evidence that China is diversifying its forex exposure away from the Dollar continues to mount. To date, most of the focus has centered around the Central Bank of China, which is passively diversifying its reserves into European and higher-risk assets. Apparently, Chinese exporters are also getting nervous about the impact of a falling Dollar on their respective bottom lines. As a result, some companies have taken to quoting prices in Euros or to adjusting Dollar-denominated prices every few months. Other companies are building assumptions of a more valuable RMB into their profit models, and setting prices accordingly. Some Chinese Exporters Prefer Euros to Dollars. The lack of fanfare not withstanding, the Chinese Yuan, or RMB, continues to appreciate against the USD. Most analysts reckon the Yuan will continue appreciating, perhaps to 6. Yuan Hits Milestone Against Dollar. Since its currency is still effectively fixed to the Dollar, China is severely curtailed in its ability to conduct monetary policy and must closely mirror US policy. Same goes for the rest of Asia, excluding Japan. Since the Fed began loosening monetary policy over the last six months, however, many of the emerging economies in Asia, especially China, have been forced into a bind. On the one hand, lowering interest rates is exacerbating the problem of inflation. On the other hand, they want to keep their currencies stable so as not to limit economic growth. In short, Central Banks must determine which is more important: But the only way to stabilize prices is to drastically raise interest rates, which will put even greater pressure on their currencies to appreciate. In the past, this has been a neutral, sometimes profitable activity. Since the Fed began cutting rates, the interest rate differential has been turned upside-down such that Central Banks are now losing money on each unit of local currency they sell in exchange for Dollars. If there is any silver lining to what many policymakers would consider bad news, it is that growth in imports is slightly outpacing growth in exports. Unfortunately, that is unlikely to allay the critics, and there are still many of them. The argument remains unchanged- that China is not allowing its currency to rise fast enough. The International Monetary Fund…urged the Chinese government to loosen the reins on the yuan. Moreover, the Central Bank of China earns interest on every Dollar it adds to its reserves but must also pay interest on every RMB note that it must issue to offset the Dollars. Since the Fed began easing monetary policy, the forex of carry the difference between what the Trading Bank receives on Dollars and pays on RMB earned by the Central Bank has completely inverted, such that it now loses basis points on average for each Dollar exchanged for RMB. Furthermore, this trend has been exacerbated because China is accumulating reserves at a faster rate than its economy is growing. The Financial Times reports:. The renminbi has started to appreciate more rapidly in recent months, rising at an annualised rate of about 20 per cent, compared with per cent over the whole of In the longer-term, say economists, China will have no choice but to allow its currency to appreciate faster, even in the face of entrenched domestic resistance. When Henry Paulson was appointed Secretary of the US Treasury last year, he made China and its purportedly undervalued currency a cornerstone of his economic plan. Ironically, there are still American policymakers who think the Yuan is appreciating too slowly, as well as Chinese policymakers who reckon it is increasing too rapidly. Accordingly, the current pace probably represents a fair compromise. Besides, inflation is threatening the US, so a slow appreciation would enable the economy to adjust to higher prices in the long term. But Chinese policymakers have stressed the need for gradual adjustment. To show that the currency is not just a one-way bet, the PBOC may try to nudge the yuan a bit lower in coming days. Most analysts reckon that the country is locked in a vicious cycle: In the short run, a more expensive currency equates to higher prices paid for its exports which only increases the trade surplus and forex reserves further, and exerts still more pressure on the currency to appreciate. What a conundrum indeed! The value of Chinese RMB against the US dollars has appreciated by over six percent in The central parity rate of the RMB was 7. Earlier this week, the Chinese Yuan recorded its highest one-day increase in value in the two years since it was famously revalued against the Dollar. The currency forex nearly. In fact, the political and economic consensus continues to maintain that the Yuan is not appreciating rapidly enough. There are still a few analysts who are bucking the trend and arguing that the Yuan is fairly valued. However, this opinion is echoed by only a small group of analysts, and an overwhelming majority continues to call for and anticipate a further appreciation of the Yuan. Forward contracts show traders are betting on an 8. The median estimate of 28 analysts surveyed by Bloomberg News yuan for a rate of 6. Yuan Rises Most Since End of Peg as China Seeks to Curb Prices. Since even before the dawn of the Forex Blog, commentators have been speculating that the US Treasury Department would officially brand China as a "currency manipulator" in its semi-annual report to Congress. Such a label is important because it would enable the US to levy tariffs and other economic penalties against China. US politicians, however, are less than pleased, and are preparing to take matters into their own hands. The Associated Press reports:. This report is the strongest case possible for our legislation," said [one high-ranking Senator] Schumer. US stops short of accusing China of currency manipulation. The official rate of inflation hit 6. Furthermore, the government recently revised its estimate for full-year GDP growth to OECD Says China Grip on Yuan Too Tight. In theory, the more expensive Chinese currency should reduce US dependence on Chinese exports and narrow the trade imbalance. In practice, the US is actually importing a greater quantity of goods and services from China and is also paying higher prices because of the appreciating Yuan. Ironically, the US Treasury Secretary is scheduled to discuss this matter with his Chinese counterpart next week, and is expected to pressure China to appreciate the RMB even faster against the Dollar. Under the current regime, the yuan is allowed to move as much as 0. China Trade Surplus Probably Held Near Record, Fueling Tension. In the campaign to pressure China into revaluing the Yuan, the US has by far been the loudest voice. However, the rapid decline of the USD may have unintentionally earned the US a new ally in its fight: Since the Chinese Yuan is essentially pegged to the USD, and the USD has declined against the Euro, the law of triangular arbitrage is such that the Euro has actually appreciated significantly against the Chinese Yuan. EU officials are no longer standing by idly, since the exchange rate is beginning to deal serious harm to its balance of trade. In fact, the EU now occupies third position on the list of countries trading the largest trade deficits with China. The Bangkok Post reports:. A tale of two currencies. In fact, China may have to increase its exposure to the dollar, according to the comments of Brad Setser of the Council of Foreign Relations: And additional downard pressure on the USD should be what China is trying to avoid. China, being the largest exporter to the U. In fact, Setser goes on to say that in order to prevent the USD from sliding even further downward against the RMB, China would have to not only retain its present stock of USD, but in fact buy even more. Can China Dump the Dollar? The speech was atypical in its level of directness, as Chinese officials tend to speak with a certain degree of circumspection if they think there is any possibility that their comments will reach the public. Although he later tried to play down his comments, saying he had not been speaking in an official capacity, the damage was done. Dollar sinks to new lows. The Chinese Yuan has crossed the psychological barrier of 7. But the general consensus is clear: Non-deliverable forward contracts show traders are betting the yuan will reach 7. Yuan Gains Past 7. Fresh from the recent G8 conference and enjoying the spotlight of the media, US Treasury Secretary Hank Paulson called in China to put its money where its mouth is, and relax its hold on the Yuan. He even insinuated that there would be repercussions for the US-China trade relationship if this demand was not at least partially fulfilled. To add insult to injury, he warned that US public opinion of China is already at a low point, in the wake of the quality control issues with Chinese exports and the subsequent recalls. Paulson wants faster China yuan rise. As a result, the EU trade deficit has set a fresh record nearly every month. Unfortunately, the Yuan basically remains pegged to the USD, and since the USD is depreciating faster against the Euro than against the Chinese Yuan, the law of triangular arbitrage dictates the Euro must be appreciating against the Yuan. EU Calls on China to Let Yuan Appreciate Against Euro. Most currency analysts view diversification as tantamount to the sale of dollar-denominated assets, but in practice, this may entail only the movement of funds into riskier dollar-denominated assets. Dollar bulls can hold off on worrying just yet. That the balance of trade between the US and China is becoming more and more lopsided in favor of China should come as no surprise to anyone. In addition, China now exports more goods and services to the EU than to America, yet another statistic which supports the notion that China can allow its currency to appreciate against the Dollar the implication here being that the Euro-Yuan exchange rate should be more important to China at this point. A more valuable Yuan would presumably make imports less expensive, thus lowering prices across the board for Chinese consumers. The Chinese currency is selling for about 7. It has risen almost 6 percent against the U. Rising Euro Is What China Needs to Dump Dollar. After the Olympics, the new leadership will be firmly in place. Third, historical exchange rate data can be regressed against various economic indicators productivity, employment, etc. The most current economic data can then be plugged into the resulting equation and tested against actual exchange rates. However, while economists agree that these techniques are the most theoretically sound, they ignore the fact that currencies today seem less tied to the laws of plain economics than they do to financial economics- capital flows. The Chinese Yuan refuses to die as a topic of conversation among forex speculators. Last week, the CCP took a step further in liberalizing its currency system by widening the band in which the Yuan is permitted to fluctuate, to. However, this did little to appease foreign diplomats and American politicians, who contend that the Yuan remains vastly undervalued, and that the Chinese government is guilty of currency manipulation. Two American Senators, Lindsey Graham and Charles Schumer, are still threatening to introduce a latent piece of legislation into Congress, which would slap a So, two questions need to be answered: Is forex Yuan undervalued and if so, should China allow it to appreciate at a more rapid pace? The first question is probably the trickier of the two to answer. Economists use admittedly crude techniques to value currencies. One method involves a calculation of purchasing power parity PPPwhich dictates that currencies should adjust in value relative to each other in inverse proportion to their respective price levels. However, this is to be expected; since income levels in China are vastly lower than in the US, one would expect prices to be lower, irrespective of exchange rates. In short, it appears as though the Yuan trading marginally undervalued, but the extent of which remains guesswork. Upon concluding that the Yuan is undervalued, should China be expected to allow the currency to fluctuate more freely i. It depends on who you ask. American officials argue that the revaluation of the Yuan represents a crucial piece of the drive to reduce the burgeoning US trade deficit. Further, a sudden revaluation of the Yuan would likely result in the relocation of Chinese production to facilities to other low-wage countries, thus doing little to stem the US trade deficit. However, it is constrained in its ability to conduct monetary policy as well as in its need to accumulate massive forex reserves, both of which would be relaxed in the event of a revaluation. While it should be clear that China is taking its plan to diversify its reserves seriously, the news should come as a partial relief to Dollar Bulls, because in this case, the diversification will not involve the sale of USD. In theory, this means the Yuan will now be permitted to fluctuate by up to. However, the west was not mollified, and continued to pressure China relentlessly to allow the Yuan to appreciate further. The yuan never moved the maximum permitted under the previous limit. Yuan Rises to Highest Since July on Wider Trading Band. Carry traders seized upon the opportunity to continue borrowing Yen at near-record lows, and selling the Japanese currency in favor of higher-yielding alternatives. In fact, the news was met with such gusto that the Euro was almost immediately propelled to an all-time high against the Yen, which continues to plumb the depths of forex disfavor. At this point, analysts and economists are feeling fairly certain that Japanese interest rates will remain at current levels in the near-term, a sentiment which supports the viability of the carry trade. Euro hits record high against yen as carry trades continue. While the plan to more actively manage its reserves remains on coarse, the likelihood that this result in diversification has been somewhat diminished. And surely diversification would put tremendous downward pressure on the USD, which means China would likely experience the offsetting of gains from diversification with the relative decline in the value of its USD-denominated assets. But, of course, if China wanted to make such a move, a big cut, our losses would be large as well. That would be very difficult to do. China diversification away from dollar would mean forex losses. In the case of China, however, monetary policy tends to have a pretty negligible effect on the currency, primarily because the Yuan remains pegged to a basket, and its appreciation is being carefully managed by the government. In order to achieve this, the firm will almost be forced to invest in non-USD denominated assets, which would surely exert downward pressure on the USD. The Shanghai Daily reports:. These steps represent the culmination of several years of intense speculation that China would make more of an effort to manage its burgeoning reserves in order to maximize returns. China to set up firm for managing forex reserves. The unthinkable has happened: Since the late s, when China was continuously inundated with foreign direct investment, it has been forced to remove the foreign currency from circulation in order to mitigate the risk of inflation. As everyone knows by now, most of these reserves are held in USD-denominated assets, a phenomenon that has heretofore provided support for the USD while thoroughly muddling US bond markets. Imagine the effect on US capital markets if China decreased its USD holdings and invested the proceeds in its own economy. The Gulf News reports:. Purchases of assets in other currencies are believed to be growing as the bank diversifies its holdings. China in dilemma over forex reserves. Having since moved past the Hong Kong Dollar, the currency is showing no signs of slowing down. American politicians and trade representatives could not be happier. Their Chinese counterparts, on the other hand, are peeved. Many Chinese exporters have been forced to lower their prices in order to offset the rising yuan and maintain their competitiveness in overseas markets. Such exporters are complaining to anyone who will listen that a more expensive yuan is already eating into their profits. Ignited by the threat of American trade sanctions and diplomatic pressure, the Chinese Yuan is now soaring against the USD. Having traded below the HKD for nearly 13 years, the Yuan is now only weeks or even days away from overtaking its Hong Kong rival. In many ways, this event is symbolic of the broader economic Chinese economic explosion and its probable outstripping of the Hong Kong economy. Some analysts are predicting that when parity is breached, Hong Kong will immediately move to tie its currency to the Yuan, while others believe that the event will trading without much fanfare. Hong Kong-owned factories in China, long spoiled by renminbi-US dollar currency stability, are less than enthusiastic about the consequences of a stronger renminbi. HK braces itself as renminbi nears parity. Last week, the Central Bank of Thailand implemented a series of draconian capital controls, designed to prevent foreign speculators from pouring funds into Thai capital markets and contributing to the appreciation of the Baht, which has been furious this year. Realizing this would ultimately be an inadequate means of grounding the Baht, Thailand has since added that an appreciation in the Chinese Yuan would take some of the upward pressure off of the Baht. Because the Yuan is effectively pegged to the USD, countries that run trade surpluses with the US and also have flexible exchange rate regimes such as Thailand must shoulder the brunt of the USD decline. The Bank of Thailand [has since] removed capital controls on foreign investments specifically destined for the stock market. Controls on other investments remained in place. China funded a study trip around Asia earlier this year looking at how various governments manage their reserves, including Singapore. China considering Temasek-like vehicle for forex management. Last week, a well-respected Japanese economist publicly urged Asian nations to take joint action in accepting the fall of the USD against their respective currencies. He encouraged them to fight the temptation to intervene in forex markets, because such could potentially cause massive instability. Most Asian nations would lose on two fronts of the USD continued to decline; their economies would suffer due to less competitive exports, and their USD-denominated reserves would become relatively less valuable. However, we have seen Asia coordinate in some areas where they normally compete, such as when India and China bid for foreign energy assets. Leading Asian Economist Urges Joint Action on Dollar. In the past, China merely issued Yuan to those in possession of foreign currency, and then proceeded to remove the currency from circulation and stash it in risk-free investments overseas. As one would expect, reconfiguring these reserves would involve not only investing in different types of securities, but also in many different currencies, steps which have serious implications for world forex and capital markets. The finance ministry [could] issue bln yuan worth of bonds with maturities of at least 10 years. The bond proceeds can be used to buy foreign currencies from the central bank which may then be invested in overseas markets. China needs new institution to manage part of huge forex reserves. This has spurred two points of speculation: In addition, Hong Kong is not subject to the level of international pressure that plagues its counterpart, so there is no real incentive for it to link its currency to the rising Yuan. As Hong Kong and mainland China become more economically and financially integrated, it seems inevitable that the Hong Kong Dollar will eventually be replaced by the Yuan. However, a merger will not make sense until the Yuan becomes fully convertible. Yuan for all, all for yuan. Chinese governmental officials have been somewhat quiet about the Chinese Yuan of late, perhaps not wanting to incite certain American politicians that are trying to lead the passage of a tariff on Chinese imports. If the USD falls, as many expect it will, China will compensate by allowing the Yuan to depreciate proportionately. China forex regime suitable, 2 pct yuan rise too small. Export-dependent countries-notably China and Japan- have accumulated gargantuan reserves over the last decade, as an alternative to allowing their currencies to appreciate. In most countries, Central Banks take the currency that foreigners used to pay exporters, and allow it to circulate in the economy. China and Japan have instead taken to hoarding their reserves in order to decrease demand and thud hold down the value of the Yuan and Yen, respectively. The Asia Times Online reports:. A couple weeks ago, I posted on this very subject- that the value of the Chinese Yuan is largely tied to inflation and interest rate differentials. There are two closely related theories in classical economics which attempt to account for changes in the relative value of currencies: The reasoning is straightforward enough: However, as in many areas of economics, the gap between theory and reality in currency markets is significant, for high interest rates often attract risk-averse foreign investors instead of repelling them, which ultimately leads to the currency increasing in value. In contrast, the Stanford economist seems to have established that the laws of parity seem to be holding in the case of the Chinese Yuan. It turns out the China-US inflation and interest rate differentials have almost perfectly mirrored the movement of the Yuan in the past year. As growth in the US began to drive inflation, the Fed raised interest rates to the extent that they currently exceed Chinese rates by over 3. This phenomenon indicates that the Central Bank has allowed the Yuan to appreciate only so much as to offset the value by which the USD has been eroded by inflation. In short, we should expect the Yuan to appreciate only by the amount that American price and interest rate levels exceed those of China. The purpose of the agreement was to help the US stem its current account deficit and simultaneously emerge from an economic recession. China seeks to learn from mistakes of Plaza Accord. If China allowed the new Yuan to circulate in the money supply, the result would be double-digit inflation. While interest rate differentials have been closely linked to relative values of the USD, Euro, and Japanese Yen, most people never figured the hot topic would ever be applied to the Chinese Yuan. After all, few international investors seriously care about interest rates in China, right? One economist, however, has established a strong relationship between the China-US interest rate differential and the value of the Chinese Yuan. His reasoning is that those who invest in Chinese assets require a return equal to the yield on comparable US investments. Since American interest rates are currently 3. The Yuan and the Greenback. When you add volatility to the chart, the story becomes less black-and-white. Over the last six months, the RMB has begun to test the limits of the. Now, the currency routinely gains or loses. While the gains have largely been offset by losses, this is still a positive development because it shows China is slowly moving towards a point in which the Yuan is allowed to freely fluctuate against the USD. With my first commentary piece, I would like to address several issues concerning the Chinese Yuan. Let me begin by saying there is a tremendous amount of information and a wide array of often-conflicting opinions surrounding the Chinese Yuan. The problem with most financial analysts is that they often fail to grasp the big picture: As most of you are probably aware, the Chinese Yuan has appreciated over 3. You can look at RMB currency futures for proof that this is indeed the consensus forecast. Both of these figures are ill-conceived and downright misleading. Secondly, and just as important, is the fact that China will likely continue to appreciate the Yuan at its own pace. On several yuan, Chinese political leaders have invoked an ancient Chinese proverb when discussing the revaluation of the Yuan. The proverb states that one should take small steps in this type of situation. In the last two months, the Chinese Yuan has soared by nearly. Compare that with the 1. While China is nowhere near letting the Yuan float freely against the basket of currencies it is currently pegged to, the last two months were certainly a small step in that direction. The Shanghai Daily News reports:. Yuan growth picks up in time to tackle trouble. The majority of the reserves have long been parked in USD-denominated assets, mostly Treasury securities. Because the RMB is slowly appreciating against the USD, when China converts these securities back into Yuan, yuan will incur massive losses. The National Bureau of Statistics warned against the exchange risk associated with tying too much money up in assets denominated in a single currency which threatens to steadily decrease the value of the reserves. China urged to switch out of dollars. At the time, commentators and economists predicted China would continue to incrementally revalue its currency, and gradually move towards a market-based exchange rate. In reality, the Yuan has appreciated by less than 1. The American political establishment has responded by introducing a new strategy, one that involves offering China a greater role on the geopolitical stage in return for dismantling the de facto peg to the USD. Specifically, the US may help Yuan negotiate a larger share in the International Monetary Fund IMFso that it will have a greater ability to influence decision making. Earlier today, China announced that the minimum amount that banks must place with the central bank will be increased by 0. This reserve requirement increase caused the yen to reach its one-week high against the USD. It came as a disappointment to Washington however that there was no further discussion of yuan flexibility, but it is likely that this debate will heat up in the coming weeks and months. Yen gains against dollar as China raises reserve requirement. A year ago, China adjusted the yuan by 2. Still, US economists believe that the yuan remains grossly undervalued and want it to be able to float more freely. Wei Benhua spoke at a press conference in Paris earlier today and indicated that China still needs more time to assess the yuan reform. According to Wei, via the Gulf Times, the management of forex reserves are carried out under three guidelines:. First is to maintain the liquidity of reserves. We need to have liquid reserves. The second principle is the safety of our reserves — we want to be very secure. The third is profitability. After you meet the first requirements, you want as much profit as possible. China needs time to assess forex trading, official says. Last week, the Treasury Department released its semi-annual report on exchange rates. Now, Secretary John Snow is under fire from Congress. By not making such a claim, the Treasury has invited criticism from Sens. Charles Schumer and Lindsey Graham, who are sponsoring legislation that would impose high tariffs on China should it fail to adjust its currency. The Washington Post reports:. Criticize Treasury on China Currency. The eagerly awaited semi-annual Treasury report on exchange rates has finally been released, and the results may have serious implications. Many members of Congress, among others, had been hoping the US would use the report to officially label China a currency manipulator, which would justify the use of trade sanctions and other economic penalties. The report may provide the impetus to propel a bill, which would punish China economically, through Congress. China Not Manipulating Currency, U. Earlier this year, US Senators Charles Schumer and Lindsey Graham proposed a bill that would slap a After meeting with senior Chinese banking officials, however, the Senators agreed to postpone voting on the bill. Senator wants China revaluation by end China caught investors by surprise last week, when it raised its benchmark interest rate for the first time in years, to 5. China must tread carefully, however, as the Yuan-USD peg severely constrains its ability to conduct monetary policy. The G7 Industrialized nations recently called on China to afford the Yuan increased flexibility. Many pundits likened the comments to similar exhortations made several years ago regarding increased Euro flexibility. Will a similar fate befall the USD this time around? For the very first time ever, China has been mentioned directly by the G7, reflecting their increased concern over the past few months. Dollar Slides as Pressure Increases on China to Revalue- Will it Matter? Last week, the World Trade Organization WTO became the most recent addition to the chorus of voices calling for revaluation of the Yuan. The most prominent advocates of Yuan revaluation, which include the United States, European Union, Japan, and the International Monetary Fund had previously invoked the correction of global imbalances as the prime justification for reform. The WTO, in contrast, is encouraging revaluation on the grounds that it will enable China to conduct an independent monetary policy and control inflation. The Financial Express reports:. The yuan on Wednesday rose the most against the dollar since a revaluation in July, following speculation that pressure from US President George W Bush and strengthening Asian currencies will force China to allow faster gains. WTO urges China to make its currency more flexible. This week, China announced it would officially do away with caps on capital outflows. Previously, a business or retail investor wishing to exchange Yuan for foreign currency had to petition the government to do so. Moreover, the amount of currency that could be exchanged was capped at a low value. With this latest move, China has signaled that it is ready to move towards a floating currency system, in which individuals would be free to buy and sell as much Chinese currency as they wished. In the short run, this should help to reduce some of the upward pressure on the Yuan. The government…made it easier for individuals and firms to buy foreign currency and invest abroad, including allowing domestic banks to invest in financial products outside the mainland. Nation to abandon forex quotas for investments. This week, Hu JinTao, Prime Minister of China, will visit the United States for the first time since he assumed power. As you probably guessed, the Yuan will be a hot topic of conversation between Chinese and American officials. However, forex markets reflect slightly different expectations with regard to the path of the Yuan. Specifically, Yuan currency futures indicate investors believe the Yuan will only appreciate 2. Non-deliverable Yuan forward contracts, which serve a similar purpose, have priced in a 3. While there remain a few analysts that believe the Yuan will rack up double digit gains against the USD this year, the majority of traders expect the Yuan to continue appreciating gradually. JP Morgan…expects the dollar to fall to 7. Currency markets bet on small yuan appreciation. In a press conference held earlier this week, the Finance Minister of Austria the nation that currently holds the rotating presidency of the EU suggested that the Yuan must be allowed to appreciate. He argued that such a step was not only in the long-term of interest of China, but would also help correct global economic imbalances. His calls for revaluation closely mimicked those of the US, with one notable difference. The Finance Minister insisted that the Yuan revaluation should be accomplished gradually, whereas American politicians would like to see it take place in one swift motion. The EU Commission reportedly backs a more gradual approach because of concerns that sudden yuan adjustment could weaken the dollar against the euro. While the last few months have witnessed rising talk of forex reserve diversification, China seems intent on preserving the status quo. This is due both to the soaring current account surplus and yuan vast sums of foreign capital that continue to be invested in China. Further, the bulk of these new reserves will likely be held in USD-denominated assets, which are valued for their liquidity. Xinhua quoted Cao as saying that it would be unwise for China to sell off its dollar assets because they are still the most reliable assets in the world. China forex reserves to rise by at least bln usd in It was probably inevitable: Earlier this week, US Senators Charles Schumer and Lindsey Graham concluded a trip to China, during which they met with top-level Chinese officials to discuss economic issues. The most important item on their agenda, naturally, was to press China to further revalue the Yuan. Evidently, Senators Schumer and Graham left the talks satisfied, indicating that the Yuan should likely break through a level of psychological importance in the near future. The China Daily reports:. But there will not be a one-off revaluation like the one in July, he said. US must grasp reality of China forex policy. The Chairman was adamant, however, that China would not execute another one-off revaluation of the Yuan, like it did last summer. Rather, the RMB will continue to appreciate gradually, so as not to shock the global economy. Since China famously revalued the Yuan last summer, trade lobbyists and protectionists have continued to urge the Bush administration to pressure China on its exchange rate policy. The label would provide a basis for trade and economic sanctions. Chinese exchange-rate policy will be guided not by politics but by calculations on how any changes will affect domestic growth. Since the US began raising interest rates, however, inflows of hot-money have declined, as the opportunity cost of waiting for a revaluation has increased. The next report is due April Interest Gap Keeps Yuan Stable, Central Banker Says. First, China announced it may soon allow interest rates to fluctuate in accordance with market forces, rather than rigidly controlling rates. These developments are important because higher interest rates would surely put strong upward pressure on the Yuan. Meanwhile, the Yuan has continued to appreciate in forex markets albeit slowlyand is on pace to breakthrough 8. China launches RMB interest rate swap transaction. Not all of the attention has been positive, however, as the US has used the Forum as an opportunity to lambaste China for its stubborn to further revalue its currency. Since last July, the Yuan has appreciated 2. While senior US Treasury officials publicly rejected applying pressure to China via tariffs and other trade sanctions, they were adamant that China move forward on its plans to appreciate the Yuan, as it now has the financial infrastructure to support a more flexible currency regime. Economists at a session on the global economy in Davos, however, pointed out that the United States and China have a symbiotic relationship and that U. Pace of China yuan reform takes center stage. On paper, the case for a revaluation of the Chinese Yuan seems rock solid: However, delve deeper into the figures, and a vastly different picture emerges. As investment in fixed capacity has declined, so has the demand for equipment and machinery, much of which is imported. So the balancing act, for the [Chinese] authorities, is to keep up the expectation of a revaluation through talk and an exchange rate that crawls up fractionally—by another percent or two here or there. Strange happenings along the China coast. This will soon change, however, as China prepares to open the new market, in which currency trading will be facilitated by 13 banks, including five that are foreign. The Central Bank will continue to set the so-called parity price and control the Yuan exchange rate via calculated intervention. However, as part of the new system, private market-makers will have more discretion in setting prices, which could spur further Yuan appreciation. AFX News limited reports:. One analyst noted that current prices are not necessarily indicative of future trends on the two markets. China mulls upper tier of market makers in new OTC market. However, as the speculation began to reach fever pitch, the same group of officials announced that their previous statement had been misinterpreted. In fact, yuan USD reserves play a vital role in helping China maintain its peg to the USD. The Daily Times reports:. China unlikely to sell dollar reserves. Earlier this week, the Bank of China issued permits to several foreign and domestic banks, which enable them to serve as market-makers for the Chinese Yuan. While the Bank of China, through its forex reserves, could still technically manipulate the value of the Yuan, this latest development makes it more likely that the Yuan will be allowed to appreciate in In fact, futures markets have priced in a 4. Some currency strategists are even more bullish, as the Financial Times reports:. Renminbi expected to rise after new trading rules. In a move that is sure to turn a few heads, China will soon allow over-the-counter trading in its Yuan currency. In addition, several domestic banks and forex few foreign banks have been awarded market-maker status in the new system, which legally enables them to buy and sell Yuan to market participants. Previously, only large financial institutions were permitted to trade the Yuan, via the interbank market. While the Yuan will still be prevented from fluctuating by more than. China to kickstart yuan OTC trade, market-maker system. In addition, the new GDP figures reveal that fixed asset investment is actually at a sustainable level. The new, more rosy picture of economic strength could fuel calls from the US for China to revalue significantly its currency, which critics say is being held at a level that grants an unfair trade advantage. In theory, the Chinese Yuan can fluctuate read appreciate by. In reality, the Central Bank allows the currency to appreciate by less than. As a result, the G8 governments are clamoring with renewed vigor for China to further revalue. Many analysts expect the Central Bank to announce such a move before the Chinese New Year on January 29th. China to Let Yuan Gain Faster, UOB Says. The advisor publicly warned Chinese firms to make the necessary adjustments, in order to prevent the revaluation of the Yuan from severely harming their prospects for success. While not indicating the size of the revaluation, Yu Yongding hinted that it would be significant, in order to help China rein in its burgeoning trade surplus. China firms told to prepare for stronger yuan. The US Treasury Department finally released its annual currency report; which contained a notable absence: Politicians and lobbyists were outraged that the Bush Administration did use the report to formally accuse China of manipulating its currency. Senators Schumer and Graham are already threatening to reintroduce a bill that would slap a Secretary of the Treasury, John Snow, tried to brush off criticism that the administration was being too soft on China, by publicly urging China to move forward on plans to continue adjusting the Yuan, which has appreciated only. Perhaps in response to recent pressure from American politicians and the IMF, the Central Bank of China made another push towards floating the Yuan by introducing foreign exchange swaps. Swaps function like futures, by enabling partied to buy and sell currencies at a fixed exchange rate on a fixed date in the future. In this case, the Central Bank has agreed to buy USD one year from now at a rate of 7. Investors and analysts are speculating that the swaps lend explicit insight into where the Central Bank believes the Yuan will be in one year. Non-deliverable forward contracts, which indicate collective investor expectations for the future value of the Yuan, are currently priced at 7. Central bank pushes foreign exchange reform. Last week, this correspondent reported that American politicians, frustrated by their inability to convince China to further revalue the Yuan, were planning on using the IMF as a vehicle for applying pressure to China.
The kind of behavior he has described is why Whites have left cities such as Detroit and Cleveland en masse.
The Jews actually controlled that Region for only 400 years, not 4,000 years.
Fact: It is easy to confuse conversational competence with academic competence in a language (Baker, 1995).