China Loosens Reins on Yuan, but Markets May See Little Benefit
The announcement over the weekend by China that it would allow its currency, the yuan, to float somewhat against the dollar - effectively an upward revaluation - ignited buying frenzies in just about every tradable asset: stocks almost everywhere, oil and other commodities, major currencies like the euro and yen.
Funny enough, among the few things that didn't gain altitude as the story unfolded over the weekend and into Monday were the two protagonists, the yuan and the dollar. The yuan edged higher; a dollar bought 6.80 yuan soon after Asian markets opened, compared to the 6.83 at which it had been stuck seemingly forever.
That's hardly the sort of move that makes the gods tremble. The tepidness could explain why the gains in so many of the other markets began to erode soon after the initial burst.
Forecasts, stated or implied, suggest that further gains for the yuan, known within China as the renminbi, may be less than overwhelming too. One-year forward contracts - bets on what the exchange rate will be a year from now - implied slightly more than a 2 percent gain for the yuan. Economists at Barclays Capital expect "up to 5 percent" appreciation in the yuan over the same period, and at UBS the outlook is for a 4 percent rise by the end of 2010.
Larry Hatheway, a UBS economist, finds less in the Chinese announcement than there might have seemed at first. Here's his thinking, set out in a note to UBS clients:
"It is important to note that there is not much clarity on just how China's exchange rate policy will change. The announcement, instead, was more a statement of principle and intent than a blueprint for action. The focus of exchange rate policy will be on reference to a basket, not a bilateral exchange rate. That means that the dollar-renminbi rate can move in either direction, even if appreciation against the dollar is likely. Further, the announcement does not herald a major revaluation and will therefore have minimal impact on global or regional trade and capital flows. . . .
"Over all, the announcement is likely to be positive for markets, if only for a short period of time. . . . The move appears to reflect increased confidence that the Chinese and world economies are growing in a stable and sustainable fashion. Almost certainly, China's leadership would not have taken this step unless they were confident about economic and financial stability."
The world could use some stability, but the yuan-dollar exchange rate could be more stable than some policymakers, businesses and investors would like. A move of a few percentage points isn't going to affect trade all that much, as Hatheway says.
A bigger move might do the world no favors, either. It would make Chinese products more expensive for Americans and others, as fellow MoneyWatcher Linda Stern points out. That might ease the competitive advantage that Chinese manufacturers have, but the beneficiaries are more likely to be in Jakarta and Hanoi than Jacksonville and Hoboken. If the markets continue to pull back, it could mean that investors are reaching that conclusion.
