China moves towards flexible currency

For years now the Chinese Yuan or Renminbi (ISO code: RMB) has been pegged in value to the US Dollar. The US has consistently argued that this kept Chinese export prices artificially low, harming Western production capabilities. Even low cost producer, India, has been complaining. That’s why this weekend’s announcement from the Chinese authorities is so important: potentially, it affects all the world’s economies.

Here are some interesting comments from BlackRock‘s BGF China fund manager Jing Ning on this weekend’s developments:

  • Chinese authorities have announced the removal of the Renminbi/US dollar peg implemented two years ago in the wake of the financial crisis. In Saturday’s statement, the People’s Bank of China (PBoC) said that given the “recovery and upturn of the Chinese economy” it was “desirable to proceed further with the reform of the RMB exchange rate regime”.
  • In a newspaper interview on Sunday, a PBoC spokesman said there would be no one-off revaluation of the currency and any changes in the exchange rate would be gradual.
  • We believe this is a positive move for the economy and should be viewed as such by the market. However, it is unlikely we will see impact of the same magnitude as the 2005 appreciation, given the consensus understanding the PBoC would have to implement this move eventually, a view that has been largely priced in.
  • Although we still think the currency will appreciate this year, there may also be small bouts of depreciation so the authorities can demonstrate that this is not an automatic one-way trade.
  • The move should be positive for industries with RMB sales and USD costs such as airlines and steelmakers as well as sectors benefiting from capital inflows such as real estate. Smaller exporters who lack the pricing power of larger peers are likely to be the most negatively affected.

On a worldwide basis, I don’t see any immediate or short term benefit for economies as the Bank of China has huge foreign currency reserves and can maintain a stable exchange rate even without the dollar peg. In the long term, however, Western economies should benefit, particularly those with larger industrial sectors such as the US and Germany.

On the downside, this is yet another nail in the coffin of permanently low inflation as the cost of goods will not continue to fall if the Yuan appreciates in value substantially. Over the long term, one of the best bets against inflation has historically been investments in stock markets.

It is important to remember that with no five year election cycle, Chinese planners think in terms of 40 year strategies, sometimes difficult for Western stock markets and politicians to grasp. What those strategies are though is difficult to say, other than they wish to be more important in the world than they are. In the 19th century China was the world’s largest economy and it seems unlikely that such a nationalistic country would not want to regain such glories and influence again.

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