Interesting Twist on China’s Currency

When I first came to China in 1992, the official exchange rate for the renminbi against the US dollar was fixed at 5.5 to one, and foreigners could only use Foreign Exchange Certificates–FEC in the vernacular of the day–for their purchases in the country. High inflation in 1993 and 1994, however, caused black market rates for the yuan to depreciate dramatically against the dollar. Many MTD readers may remember trips to Silk Alley in Beijing, not to buy North Face jackets, but to exchange dollars for local currency. At its low point, I can remember getting 13 yuan for each dollar I handed over to the man at the back of the stall.

The dramatic difference between the official exchange rate and the black market rates put pressure on China to adjust the official rate and to eliminate the system of restricting foreigners to FEC. In 1994, China made the first of its currency reforms. The FEC became a footnote in China’s monetary history, and the country re-set the exchange rate at approximately 8.7 Yuan to the dollar. From then until 1997 and the onset of the Asian Crisis, the renminbi appreciated slightly to 8.3 against the dollar, where it remained for nearly 10 years.

In July, 2005, China adjusted its monetary policy once again, releasing the yuan from its peg against the US dollar. For the next three years, the yuan appreciated by nearly 20 percent, climbing to 6.83 to the dollar by July, 2008, and there it has remained. Despite the nearly 20 percent decline in the value of the dollar against the Euro in 2009, China has maintained the value of its currency at the 6.83 to one level. In the wake of the global economic crisis, many argue that such a peg may trigger global imbalances.

Certainly the Europeans have cause for concern. In March of this year, one euro only purchased 8.6 yuan. Today, that same euro can purchase over 10. The dramatic depreciation of the yuan against the euro makes China’s exports to Europe less expensive, and Europe’s exports to China more expensive and less competitive. Meanwhile, the relationship between the yuan and the dollar remains unchanged.

Will China once again adjust its monetary policy? Prior to President Barack Obama’s visit to China last week, the People’s Bank of China hinted that it may end the renminbi peg to the U.S. dollar. In its third-quarter monetary policy report, the bank departed from the standard language of keeping the yuan “basically stable at a reasonable and balanced level.” Instead, the bank said foreign exchange policy would take into account “capital flows and major currency movements,” a reference to the large speculative inflows of capital that China is receiving and U.S. dollar weakness.

However, a growing body of opinion among China watchers suggests that we are unlikely to see any changes in China’s currency policy until well into 2010. For example, Morgan Stanley Asia chairman Stephen Roach dismisses the notion that China’s currency policy is creating structural imbalances in the global economy. Instead, he believes that the economic crisis was the result of excessive consumption in the U.S., a lack of policy to regulate excessive risk-taking in the banking sector, as well as mistakes in a lack of internal consumption in surplus savings for countries around the world.

The world is always trying to give countries advice on their currency policies, he told reporters in Beijing. “And that is the least type of advice that a dynamic, growing and developing economy such as China wants to take,” he said. “Japan was advised to let the yen appreciate sharply. Look at what Japan is today.” As a developing economy, Roach believes that a developing financial system needs an anchor, and a stable currency is a good anchor.

Jing Ulrich, Chairman of China Equities and Commodities at JP Morgan, doesn’t see any changes on the horizon until at least the second half of 2010. By then, when she predicts that exports will return to growth, China will probably let the yuan start rising against the dollar in her opinion.

Jerry Lou, China strategist for Morgan Stanley Asia, agrees, and believes that the current regime of a de facto peg against the U.S. dollar will be unchanged at least through mid-2010. In his latest report, though, he offers an interesting twist on his reasons for saying so.

Contrary to the consensus view, Lou believes that it is not in the interest of the United States for China to revalue the renminbi at this time. Here is what he wrote:

China maintains a managed currency regime to support its exports, which ensures it keeps buying the US dollar and US treasury bills. For the US, funding the US government deficit in the coming years is probably going to be a more important issue than creating potentially uncompetitive manufacturing jobs, in my opinion. Would the US want China to change its currency regime now?

With trillion dollar deficits for “as far as the eye can see,” perhaps that is the reason why the Obama Administration has been relatively silent on China’s exchange rate?

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