the Chinese renminbi “devaluation”


Every day the Chinese government sets a mid-point for trading of its currency prior to opening.  The renminbi is then allowed to trade within a 2% band on either side of the setting.  At this morning’s setting, Beijing put the mid-point 1.9% lower than it was yesterday.  This is an unusually large amount and can be (is being) read as an effective devaluation of the currency.

What does this really mean?


In the late 1970s, when China made its turn away from Mao and toward western economics, it chose the tried-and-true road toward prosperity trod by every other successful post-WWII nation.  It tied its currency to the dollar and offered access to cheap local labor in return for technology transfer.

Late in the last decade, the country ran out of cheap labor.  So it was forced to begin to transform its economy from export-oriented, labor-intensive manufacturing to higher value-added more capital-intensive output and toward domestic rather than foreign demand.  The orthodox, and almost always not so successful, method of kicking off this transition is to encourage a large appreciation of the currency.  That causes low-end production to leave for cheaper labor countries like Vietnam or Afghanistan.

China, armed with a cadre of young, creative economists with PhDs from the best universities in the West, decided to do things slightly  differently–to hold the currency relatively stable and to boost domestic wages by a lot to achieve the same end of making export-oriented manufacturing uneconomic.  The idea is that this doesn’t bring the economy to screeching halt in the way currency appreciation does.  So far this approach seems to be working–although the shift does involve slower growth and a lot of domestic disruption.

At the same time, forewarned by the immense damage done to Asian economies by speculative activity by the currency desks of the major international banks during the 1997-98 Asian economic crisis, China elected not to let its currency trade freely.

what’s changed?

For some years, China has been upset about the fact that despite being the biggest global manufacturing power, and by Purchasing Power Parity measure the largest economy on earth, it has virtually no say in world financial or trade regulatory bodies.  Those are dominated by the US and EU.  The main reason for China’s limited influence is that its financial system isn’t open.  (The other, of course, is that fearing China organizations like the new US-led Pacific trade alliance pointed excludes the Middle Kingdom.)

So China has been gradually lessening state control over the banks, the financial markets and the currency, in hopes of being admitted into the inner sanctums of bodies like the IMF.

In one sense, this is why China is becoming less rigid in its control of renminbi trading.

why now?

There’s no “good” time to let a currency float.  China doesn’t want to cede control over currency movements at a time when the renminbi might appreciate a lot, since that would be a severe contractionary force.  On the other hand, it doesn’t want the currency to fall through the floor either, since that would result in new export plants sprouting up all over the place.

China is growing more slowly than normal and is experiencing currency outflows as a result of that.  Letting the currency slide a bit relieves some of the pressure–although it may simultaneously attract speculators to try to push the renminbi lower.  So, yes, it is a sign of economic weakness.  At the same time, the loosening comes shortly before the IMF will decide on admitting the renminbi as one of its reserve currencies.  And it follows by a few months Beijing allowing banks to issue certificates of deposit at market rates, rather than at yields set by central planners.  So it’s also a step toward a healthier, more economically advanced, future.

my take

I think worries about the stability of the Chinese economy are overblown.  I also think that traders are using the Beijing move as an excuse for selling that they’ve been wanting to do anyway.  Beijing may have been the trigger for this, but it isn’t the cause.





renminbi as an international currency–more steps forward

About a month ago, I wrote a post summarizing the steps the Chinese government has already taken on its march to join the US dollar as a world reserve currency.  That is to say, Beijing wants the renminbi to be used not only as a reference currency in the worldwide trade in goods and services, but also to be held as a store of value in the coffers of the world’s private and government central banks.  Almost no one believes that’s Beijing’s final destination, however.  The ultimate goal, I think, is to supplant the dollar, rather than supplement it.

For a while now, China has been encouraging companies involved in international trade to construct and settle their transactions in renminbi instead of (mostly) dollars.  To this end, it has been allowing more of its currency to seep out of the mainland and be held legally in foreign banks, notably in Hong Kong.  In addition, it has been supplying currency to foreign central banks who want to provide renminbi to firms that make up their countries’ side of the deals.  One catch, though:  the money can get out of China very easily.  Getting it back in is another matter.

Last week, though, according to the Financial Times, Beijing took another step.  It is now encouraging Chinese companies that are setting up businesses or making acquisitions abroad to do their business in renminbi, as well.   Such deals have to be approved by Beijing, just as any foreign currency purchase would be.  Same catch, though:  easy to get the money out, but once the cash leaves the mainland, there’s no guarantee it can get back in.

Of course, interest rates are low, so the opportunity cost of holding renminbi in short-term deposits isn’t high.  And if you think the Chinese currency is undervalued, you may be willing to bet on having it appreciate.  So you might say it’s kind of like gold, only without the physical storage difficulties.

There are two conclusions that I think we can draw from this development:

–the targets are unlikely to be publicly traded companies in the US or Europe.  I can’t imagine pension funds or index funds voting in favor of deals that would land them with hundreds of millions of dollars worth of renminbi that they would have to dispose of.  I don’t this is that big a change in strategy, since Washington and the EU have made it pretty clear they’ll throw up all sorts of (mostly bogus) political obstacles to almost any deal where the buyer is Chinese.

–If this initiative is successful, China is going to be piling up lots more dollars.  China was involved in a tenth of the global merger and acquisition activity last year.  The Economist predicts, I think, that this is just the tip of the iceberg.  My take on this thrust, plus the foreign aid to Latin America and Africa, and the offers to buy the government bonds of ailing European countries like Greece, is that a good part of China’s motivation has been to try to divest itself of as much of its gigantic hoard of US Treasury bonds before the profligate ways of Washington cause them to lose value.  In fact, the cover of the Economist issue (November 13, 2010) that I linked to above has the Chinese buyer offering a wad of American cash.

Suddenly, however, the emphasis has changed from shrinking the central bank’s pile of greenbacks to draining the domestic economy in China of part of its supply of “redbacks,” as some have begun to call the renminbi.

Why?  My guess is that Beijing has worked out that it can’t reduce the risk of holding tons of dollars by just spending them as fast as it can. More just keeps on coming in.  And it may well lose as much on bad acquisitions as it would on depreciation of the dollar.  The only real solution to its currency risk is to push harder to get more renminbi circulating outside the mainland and see what happens.

Step one will be to see if there are any sellers willing to take Chinese currency.

Investment implications?  This is more something to keep an eye on than to worry actively about.  An increased willingness of China to hold onto dollars would arguably be good for the US currency, at least for a while, and would imply that interest rates might stay a bit lower than they would otherwise.  But let’s see how big the offshore renminbi market gets before doing anything else.