China Releases the Brake

By Dr. Lynn Reaser

After months of global critique and pressure, China released the peg on its currency last week.  The adjustment was modest, with an appreciation of just 0.6% for the week as a whole.  What can we expect going forward and what will be the impact?

Having just returned from China, it is clear from discussions with various government officials that policy leaders in the country intend to keep the currency on a tight leash.  The view is that most Chinese companies do not have access to hedging facilities and need a relatively stable currency to conduct business. 

The first day of trading after the peg was removed saw the Chinese yuan rise about 0.4%.  The following day, the currency shed about half of that gain.  It is clear that Chinese official do not want investors to place one-way bets on the direction of the currency and do not want to see wide swings of volatility.  The maximum increase or decrease permitted each day is probably about 0.5%.

The general view of Chinese leaders is that a stronger currency is unlikely to materially shrink America’s trade deficit.  A large appreciation of the yuan and a commensurate rise in the cost of Chinese imports would probably mainly shift U.S. imports to other countries, such as Viet Nam.

Many Chinese economists and leaders would ultimately like to have a freely floating currency, but the financial system needs to be more fully developed before that will realistically happen.  In the meantime, the return of China to a more flexible exchange-rate regime will hopefully forestall measures in Congress that could set off a series of restrictions on trade on both sides. 

Both the U.S. and China will benefit from more trade and investment between our two countries, not less.  Let’s hope that China’s managed float of its currency will allow that to happen.


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