Is China Buying the Euro?

After dropping precipitously from over $1.50 at the beginning of 2010 to a four-year low of $1.19 on June 7, the Euro has been recovering ever since. On Friday, the Euro closed at $1.26, up sharply in the week’s last three days of trading.

Not wanting to suffer the same plight as Greece, Germany, the United Kingdom and other European countries have recently announced various austerity measures, and are making strong commitments to reduce their ballooning deficits. This new fiscal conservatism on the part of the European countries is undoubtedly restoring confidence in the Euro amongst currency traders.

But, there may be something else at work as well.

On June 19, The People’s Bank of China (PBOC) announced that it would abandon the peg that has kept the Yuan valued at approximately 6.8 to the United States dollar over the past two years, allowing the Chinese currency to appreciate gradually. Rather than pegging China’s currency to the dollar, the PBOC said that it would instead manage the value of the Yuan in reference to a basket of currencies. Although the exact composition of this basket is considered by China to be a state secret, currency experts believe that it may include anywhere from 15 to 20 different currencies. The Euro, as the world’s other major currency, is undoubtedly a key element.

Therefore, the fact that the sharp increase in the value of the Euro in the final days of trading last week coincided with a similarly sharp increase in the value of the Yuan should come as no surprise. Neither should the sharp rise of the Japanese Yen and the British Pound, other basket currencies, on Thursday and Friday.
As early as the beginning of June when the Euro reached its low point, some market watchers believed that the Chinese had already begun buying the Euro, enabling the currency to stabilize. Last week’s currency movements suggest that China’s new basket is beginning to operate, and that the Euro is likely to be the biggest beneficiary.

As China allows the Yuan to increase in value against the U.S. dollar in the coming months, expect to see corresponding increases in the Euro and other basket currencies. With over $2.5 trillion of currency reserves, roughly the same amount of financial assets held by the U.S. Federal Reserve, China is now playing a lead role in determining the value of not only its own currency, but those of other major countries as well.

No comments yet... Be the first to leave a reply!