- Blog Post
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So far, the PBoC has allowed to RMB to move within a new trading band of 8.1101 to 8.1102:
Dealers said they expected the central bank to keep the currency around 8.1100 for weeks, or even months, after the yuan was mainly traded at 8.1101 and 8.1102 on Friday.
That feels a bit like China's "managed float" that China had before Thursday, a managed float between 8.28 and something like 8.2765 ...
It is obviously too early to tell, but I wonder if the new "basket peg" will end up putting the PBoC in an impossible position.
To avoid political trouble (renewed trouble that is) with the US, the Chinese need to suggest that, at least over time, there will be somewhat less "management" and the RMB will be allowed to appreciate. If the RMB is still at 8.11 at the end of this year, Congress will be back on China's case. With some reason in my view: intervention on China's scale strikes me as a large enough to change the composition of US output, favoring interest sensitive sectors in the US at the expense of exporting and import competing sectors.
But to avoid creating an incentive for everyone (or at least everyone who can find a way around China's controls) to bet on further appreciation of the RMB, whether against the dollar or against a basket, China needs to signal that this is NOT the first of many moves.
I am not sure China can communicate different messages to different audiences.
Right now the focus seems to be on deterring speculation on further moves.
Yu Yongding is always worth listening to, though right now he sure seems intent on staying on message -- no repeat of Davos (that itself is information). The FT reports Yu "did not think China would allow dramatic changes in the exchange rate."
"The principle is stability as well as flexibility," Prof Yu said. "We don't want to encourage speculative capital inflows."
Washington DC would prefer less emphasis on stability and more on flexibility, so that hardly is the message DC wants to hear. Of course, the US government itself is an interest-sensitive sector, though few in DC think in those terms; Congress certainly should not focus on China to the exclusion of the USA. Washington DC wants China to revalue, big time, but not to make painful changes to US fiscal policy. That preference set may prove a bit difficult to satisfy - a major change in the RMB (not a 2.1% one time revaluation) that reduced Chinese reserve accumulation might put pressure on US rates - and ultimately pressure on Congress to do more to reign in the US fiscal deficit. The fiscal deficit is shrinking for cyclical reasons, but remains large relative to the United States' anemic personal savings.
Looking ahead, the big debate is likely to be between those - like Roubini - who see China's move as the beginning of the end of the Bretton Woods 2 system of Asian central bank financing of US deficits, and those who see China's move as a new beginning for Bretton Woods, not the beginning of the end.
After all, if China clings to 8.11 like it clung to 8.28 and if the rest of Asia is unwilling to appreciate against China, Asian central banks will still be in the fx market -- big time. Personally, I would bet on a "new beginning" at least for a while, but I also suspect the "new beginning" will give rise to the set of pressures that ultimately cause the system to end. Big changes usually happen through a series of smaller steps, and big decisions are taken only after intermediate steps are tried and found wanting.
I don't know if China intends to hold fast to 8.11, or more accurarely, hold to 8.11 barring a big move in the euro/dollar, which, in the context of a basket peg, implies some changes in the RMB/ $. But if China wants to hold on to 8.11 or its equivalent in the context of basket peg, it may be in for a rough ride. Its trade and current account surpluses will keep on rising, capital inflows into China will continue, and the pace of its reserve growth will accelerate from its already insanely high level.
THREE UPDATES (SATURDAY, @ 2.30 PM)
1) The FT (Martin Wolf?) gets it just about perfect (at least in my view) in this editorial comment:
There are risks in moving away from the old market equilibrium, which was stable in the short term, even if unsustainable in the long term. Abrupt reserve diversification by Asian central banks, or the fear of it, could trigger a sharp sell-off of US bonds and the Ã‚dollar by private investors.
Conversely, expectations of future revaluation are likely to generate a wave of speculative capital flows into Asia. Currencies of countries with relatively open capital accounts could appreciate rapidly. If Asian central banks want to slow the rise, they may have to increase, temporarily, their purchases of US dollar assets.
Yet the risks of adjusting now are less than those of adjusting later. The best way to minimise the risks is to ensure the process does not get stalled half way - with limited adjustment in Asia and no response from the US. Alas, that seems all too likely.
The Heritage Foundation, on the other hand, is in a somewhat different place.
2) More from Yu Yongding in Saturday's FT. Remember, he sits on the monetary policy committee of the People's Bank of China -- and he is a bit more willing to talk than the average central banker!
Many analysts said it would be impossible to understand China's new exchange rate mechanism until it had been in operation for some months at least, when estimates might be made as to the currency basket adopted by the People's Bank.
However, the central bank could confound such hopes, since it is not clear how tightly the renminbi's level will be tied to the basket.
"In the [central bank] announcement, the word 'reference' was used, [while] words like 'link' and 'peg' were not used. This is a very important point," says Yu Yongding, a member of the bank's monetary policy committee and a longtime supporter of revaluation.
"By using the word reference, the central bank will maintain an important role in determining the exchange rate - that's my personal view," Prof Yu said.
3) Count me as proud member of Paul Volcker's camp. My (limited) experience suggests that if a country is running a 7% of GDP current account deficit with a 10% of GDP export base, it is better to run the risk of being a Chicken Little rather than pretend all is well and not sound a few alarms.