China’s revaluation of its currency came as something of a surprise. Beijing has been under considerable international pressure to increase the value of the yuan, but Chinese economic officials had countered that doing so was not yet in their country’s best interests. The change in position reflects a political, rather than an economic, decision. Although there is likely to be little real impact on Chinese trade, the move does show Beijing’s sensitivity to the concerns of its trading partners.
China first pegged its currency to the U.S. dollar in 1994. In 1997, during the Asian Financial Crisis, Beijing let the value float to 8.277 yuan per dollar, where it has remained ever since. That stability has been a key part of China’s economic success: A fixed and transparent exchange rate has bred confidence in investors who have been reassured that their projects will not be subject to arbitrary swings in currency rates.
But China’s blistering annual growth of up to 9 percent, which has depended greatly on exports, has yielded a massive trade surplus, mostly with the United States. That, in turn, has generated criticism that Beijing has kept the value of its currency artificially low to make its products more competitive, thereby forcing job losses in the U.S. and other countries that trade with China. This chorus of complaints has been growing louder, with U.S. congressmen threatening legislation that would impose new tariffs on Chinese goods.
While China’s economic officials had maintained that any revaluation would be premature, other considerations apparently prevailed. Last week, China’s central bank announced that the yuan would be allowed to rise from its current value to 8.11. In addition, the yuan would be allowed to move within a trading range of 0.3 percent above or below the previous day’s closing price. This is known as a “managed float.” In addition, the bank said the yuan’s value would be pegged to a basket of currencies, rather than to the dollar alone. The makeup of that basket, and the exact mix of currencies, remain a secret.
While the initial revaluation is considerably less than the 25 percent that some critics had demanded, the currency could continue to climb if Beijing lets market forces work on the yuan so that it reaches the maximum-allowed value each day. It is unclear whether China intends to permit such appreciation.
Despite the many questions, reaction has been positive. Chief Cabinet Secretary Hiroyuki Hosoda said the revaluation was “appropriate given the country’s role in the global economy” and the “first step toward the internationalization of the (Chinese) economy.” U.S. Treasury Secretary John Snow called the move “extremely positive.” Japanese businesses, while taken off guard by the sudden decision, have been sanguine about its impact on them as the change in value is relatively small. Which is most likely to the point.
China has long argued that it cannot afford to revalue substantially. A significant rise in the exchange rate would undermine the most vibrant component of the Chinese economy. A slowdown in exports would ripple throughout the country and seriously damage a leadership that increasingly bases its legitimacy on the ability to deliver more prosperity.
But protecting exports means that foreign critics are unlikely to be mollified. Then again, some are unlikely to be satisfied in any case, as most economists agree that the yuan’s exchange rate has little impact on unemployment rates and trade balances. The move to an unknown basket of currencies means that the exchange rate will be less transparent, opening the door to charges of currency manipulation by China’s central bank. With $600 billion in foreign currency reserves, China will be able to intervene in markets — as Japan has done — to dampen any precipitous rise in the value of its currency.
There is another downside to the move: Economists worry that China’s financial system is not prepared to handle the money flows expected to follow hereon as investors try to exploit flexibility in the exchange rate.
It is predicted that a large amount of investment money will rush into China in anticipation of further revaluations. That is precisely the kind of instability that led to the Asian Financial Crisis in 1997, which Chinese officials have managed to avoid by pegging their currency to the dollar.
Still, last week’s decision takes pressure off the Beijing government. It can now say that it has responded to the concerns of its trading partners, in particular the U.S. That will quiet calls for retaliation and make China look like a responsible nation. It also underscores the increasing importance of China to the regional economy. After Beijing’s announcement, Malaysia announced that it would float its currency. And the Japanese yen jumped in value as well.
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