The New Renminbi, Day Two: Fluctuating In Both Directions

The financial world got all excited yesterday over the Chinese central bank's move to unleash the renminbi (RMB), a move that would help balance consumption and savings in the world economy, or hasten economic growth, depending on which commentator you pay attention to. Whatever the motivation and intended result, to the markets it looked like great stuff, and the RMB traded up the day of the IPO about as much is allowed. In second-day action, however, Chinese state banks sold RMBs and bought dollars, perhaps showing the government's intention to limit the appreciation.

We should know by now that the Chinese government is highly methodical, incremental, and seldom very clear in its explanations of economic measures. Therefore it should surprise no one that any change in the Chinese currency regime, which has been a great advantage in its growth in the last 20 years, will be deliberate.

Some observers see yesterday's move as more political than economic, and timed to take the heat off China's leadership at the coming G20 get-together of economic ministers. From the Financial Times:

Although Chinese officials said on Saturday the decision was taken for domestic reasons, the announcement comes a week ahead of a G20 summit in Canada that was shaping to be something of a showdown over the level of the Chinese currency.

By indicating that the peg between the renminbi and the US dollar is now likely to be broken, Beijing has "stolen the thunder" from the US and other governments which hoped to use the summit to put pressure on China, said Eswar Prasad, a former IMF China economist now at Cornell University.

The yuan today surrendered some of its increase from yesterday, when it climbed the most since a July 2005 revaluation. It traded at 6.81 per dollar as of 11:34 a.m. in Shanghai. The drop indicated that officials will encourage two- way fluctuations in the exchange rate, even as they anticipate the currency will appreciate over time.

Early Tuesday, China's central bank set a key daily reference rate for the renminbi at its highest level in five years, up 0.4 percent from Monday and in line with that day's gain in over-the-counter trading. It was a closely watched move that suggested Beijing was open to a further rise in the exchange rate.

But by midday, financial news agencies were quoting unidentified currency traders saying that large state-owned banks were buying dollars for renminbi. The news spooked investors and suggested that the Chinese central bank was trying to limit any gains in the currency.

By the end of Tuesday, the renminbi, also known as the yuan, closed down 0.2 percent at 6.8136 renminbi per dollar.

Partly, they say, this is because of the limited size [of the liberalization]. The renminbi offshore forwards market on Monday was predicting an appreciation of just 2.3 per cent by the end of the year. At that rate, very roughly speaking and holding other things equal, it would take China more than a decade to eliminate the currency's undervaluation, estimated to be in the range of 25-40 percent.

As an aside, if you are curious about why there are two names for the Chinese money, yuan and renminbi, here is what Wikipedia tells us (I don't get the distinction; maybe an astute reader will write in with a clarification):

The yuan is, in the Chinese language, the base unit of a number of modern Chinese currencies. The distinction between yuan and renminbi is analogous to that between the [U.K.] pound and sterling; the pound (yuan) is the unit of account while sterling (renminbi) is the actual currency.