International | Apr 16 2012
– Beijing expands its currency peg range
– Yuan no longer considered deeply undervalued
– Move applauded across the globe
By Greg Peel
When China began “emerging” in a big way from the turn of the century, the renminbi was pegged directly to the US dollar. [Note that “renminbi” and “yuan” are interchangeable but renminbi is the official label and yuan is a regional variance.] At the same time US and other international companies were shifting their manufacturing bases to China to exploit lower wages and reduce costs. This shift somewhat inadvertently set China on track to be the new global manufacturing powerhouse, in a story not dissimilar to Japan's emergence in the 1960-70s.
China then proceeded to flood the world with cheap goods and in so doing build towards a substantial trade surplus. Had the renminbi floated at the time, it would have gained in value to the US dollar and those goods would have gradually become less cheap in dollar terms. The currency was pegged to the dollar however, meaning China's trade surplus grew and trade deficits grew in the US, Europe and elsewhere on the flipside. Beijing then proceeded to “lend” that surplus back to the US by becoming the biggest holder of US bonds. This created what became known as the great “global imbalance” – another factor considered part of the extensive and various drivers of the GFC.
Beijing made its first notable concession in 2005 when it released the renminbi into a peg “range” of plus or minus 0.5% to a basket of global currencies of which the US dollar is one constituent. This was the first step on the way to a fully floating currency, but Beijing was in no hurry. As the world approached the GFC, the renminbi was considered by economists to be anything up to 40% undervalued, giving China a huge global export advantage.
This has drawn the ire of US politicians and officials in particular, including those more parochial politicians with large manufacturing bases in their states. On the other hand, China has since used the GFC as an example of how America is a poor money manager and shouldn't throw stones from a glasshouse. Despite the diplomatic ructions, Beijing has always intended to reform its financial markets and shift its currency towards a free-float in order to cement China as a leading player in global trade and finance. Beijing simply hasn't wanted to move too quickly.
The risk of a sudden floating of the renminbi would have been a big revaluation which would have hit China's export industry vary hard and derailed the emerging country's economic growth story. Instead, the shift to a range-peg against a currency basket has allowed for a 30% increase in nominal value to the US dollar between 2005 and now, with 2010 seeing 4% appreciation and 2011 seeing 5%. And as the renminbi has been appreciating, China's economic growth has been slowing.
The slowing of China's rate of GDP growth from double digits in recent years to around 8% today is a reflection of Beijing's deliberate monetary policy tightening measures – mostly intended to curb the property bubble – and fiscal measures, as well as the revaluation impact. Having received quite a scare in the GFC, sparking a huge fiscal response from Beijing, the government has quietly been trying to shift China's GDP away from its reliance on exports and towards greater domestic consumption. If nothing else, Europe has been China's biggest export customer but is now sliding into recession.
The result of Beijing's policies, and macroeconomic factors, has been the creation of fear across the globe China's economy will come in for a “hard landing”. While this fear has seemed omnipresent, and global markets have jumped at every new piece of Chinese data, to date a “soft landing” is more apparent from the evidence. Either way, China's economy is currently “landing” and no longer still taking off, which eases the upward pressure on the renminbi. Indeed, economists now suggest the renminbi may have reached an equilibrium point in its value relative to the US dollar.
What better time to take the next step towards free float?
This is largely the response from economists today as they assess the implications of Beijing's announcement on the weekend that the renminbi float range around the basket value will be expanded from plus or minus 0.5% to plus or minus 1%. The expansion allows for the opportunity for the renminbi to shoot up, thus undermining China's export industry, but the expectation is that it won't shoot up because China is slowing rather than rocketing along like it had been.
The timing is thus seen as a clever move from Beijing, reflecting growing maturity of economic and financial management. The timing has also drawn smirks from those noting this weekend sees another round of G20 and IMF meetings in Washington which are the usual forums of grumblings from the US and elsewhere over China's pegged currency. The usual suspects may have to bite their tongues this time.
All up the move is seen as a win-win, and a step along the path to China's ultimate equality as a member of the global financial and trade communities. “I think the step should be welcomed by foreign countries, especially the United States, which have been calling for reforms,” a China economist at OCBC Bank in Singapore told Reuters. “This is also related to growing domestic calls for economic reforms”.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
