China Relaxes Yuan Peg to Dollar

While the rulers of China claim to be communists, they have operated a brash mercantile economic policy for the past couple of decades. Over the week-end and in advance of the G-20 meeting in Toronto in a few days, the People's Bank of China (the central bank) announced that it would "proceed further with reform" on the exchange rate front. As a result, the local currency is at its highest level against the dollar since 2005.

For better or worse (mainly worse), the PCOB has kept the yuan's exchange rate with the US dollar constant. Moreover, the level chosen has put pressure on other exporters in Asia who have allowed their currencies to float. The result is a huge trade surplus for China and a significant risk of inflation there. Letting the yuan rise will reduce some of the pressure and, everything else being equal (is it ever?), the surplus should shrink as well.

Of course with any change in economic policy, there are winners and losers. The exporters in China are the obvious losers and especially commodity producers. As Reuters noted, "Aluminum Corp of China, Zijin Mining and PetroChina face dollar-linked prices for their output, but their costs are in yuan." Non-Chinese retailers will suffer too because all the cheap products they sell that are made in China will now cost them more. Clearly, the employees of these companies will suffer, too.

Winners include Chinese consumers, the country's airlines and automakers as well as companies that export to China. The latter include firms like GE, Proctor & Gamble and Caterpillar. Chinese financial firms, and especially its insurers, will benefit from a stronger currency.

The PCOB sets the rate everyday and lets the market move the currency 0.5% up or down during trading. Today, the yuan traded up 0.42% to 6.7976 per dollar. Callum Henderson, global head of FX strategy at Standard Chartered Bank in Singapore, told Reuters, "It is still too early to say what the PBOC is going to do in the coming days but we expect the trend to be gradually lower rather than volatile. Tomorrow's fixing is awfully key in terms of the sentiment of the market. One can pontificate on what is going to happen based on one day, but frankly it is a guessing game on what is going to happen. We will have to see the fixing tomorrow and that should set the tone for the next couple of days."

The Global Times, a popular tabloid in the People's Republic, wrote today, "The renminbi [a/k/a yuan] should appreciate, but not now, only when our national power has also risen. We're still a country that relies on exports. The renminbi's appreciation should be based on the national need, and should not be forced on us by any other country." So perhaps, this is just pre-G-20 window dressing. The next few weeks, not days, will show whether that is the case or not.

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