NationStates Jolt Archive

Resident economists, please help me in understanding what will be effects of a Yuan revaluation.

What will be the immediate effects?

What will be the long term effects?

Will it increase the cost of goods exported thereby making chinese goods uncompetetive ?

What will happen to the value of the enormous US treasury bonds that China holds ?

My understanding is, if the Yuan revalues to a higher position, China would be getting fewer dollars in return for the bonds which would kinda lead to a situation where the Americans had their cake (cheap goods) and ate it too (lesser value of chinese held bonds). Is it correct?

Also, what would happen if the PRC commies keep it pegged as it is? Should'nt the national currency reflect actual ground situation - rising wages in coastal china and increasing costs ? Will the artificial pegging lead to inflation ?

Will the threat of limiting Chinese imports work? Is that not against WTO regulations or some such regulations?

Please enlighten. :)

Some background links

http://en.ce.cn/World/biz/200506/03/t20050603_3966981.shtml
ADB: Yuan revaluation won´t affect US trade deficit

http://www.time.com/time/asia/magazine/article/0,13673,501050523-1061554,00.html
Speed Read: Yuan Revaluation
The Fight over China's Currency

http://news.bbc.co.uk/2/hi/business/4623435.stm
China says no to yuan revaluation

http://www.bloomberg.com/apps/news?pid=10000177&sid=ap2ZDx2nQKi0&refer=market_insight
Wal-Mart, Gap Look to India as China's Yuan May Rise

July 11 (Bloomberg) -- U.S. retailers, including Wal-Mart Stores Inc., Gap Inc. and Chico's FAS Inc., are increasing purchases of inexpensive clothing and jewelry from India as they brace for rising costs when China, their biggest overseas supplier, revalues its currency.

Wal-Mart, the world's largest retailer, is boosting purchases from India by 30 percent to $1.5 billion this year. The Bentonville, Arkansas-based chain has an 86-employee purchasing office in Bangalore, India, from which ``we could export a lot more,'' Wal-Mart International Chief Executive John Menzer said during a conference in New York on June 13.

Retailers that bought about $65 billion in Chinese goods last year are turning to India because the anticipated yuan revaluation may increase their costs by 10 percent over two years, said Ken Mark, managing director of Martello Group in London, Ontario, a consultant who's co-written Harvard Business School case studies on Wal-Mart. Mark's figure is based on estimates of the yuan's rise versus the dollar.

``Retailers could shift the fall season to India,'' said Norbert Ore, committee chairman of the Tempe, Arizona-based Institute for Supply Management, the world's largest association of purchasing managers. ``We've gotten into a virtual world where buyers can quickly move to the lower-cost country,'' he said. ``If you see a shift in the yuan, you are going to have some impact.''

1. The Chinese banking system, and thus economy, would take a HUGE blow.
2. Over time, things will stabilise, although on a lower level than seen now.
3. The same advantages China has now: A huge labour force, a huge number of consumers, cheap labour (as well as new ones like more education and infrastructure) will remain.
4. China stays on course to become the world's most powerful economy, albeit now with less direct control of the government.

One effect of the revaluation would be raise in consumer products in the US because the Chinese manufactorers would have to do so to stay in the market. The Chinese have an ever increasing supply of US currency. What would be worse than a revalutaion for the Chinese would be if the dollar declined in value.
(I'm a novice in the economic field, but I hope that helps.)

One effect of the revaluation would be raise in consumer products in the US because the Chinese manufactorers would have to do so to stay in the market. The Chinese have an ever increasing supply of US currency. What would be worse than a revalutaion for the Chinese would be if the dollar declined in value.
(I'm a novice in the economic field, but I hope that helps.)

Well you could look at it that way. But the US has an appetite for cheap goods. It will turn to other nations for them. China will lose its luster as the Walmart of the east.

Well you could look at it that way. But the US has an appetite for cheap goods. It will turn to other nations for them. China will lose its luster as the Walmart of the east.
If you look at it in current terms. The US is addicted to those cheap goods, nearly all of our products are produced in China. It would take some time for the US to adjust to Chinese revaluation and to find another source. On a sidenote, that was a very good comparision.

Marrakech is right. China would quickly lose its appeal as a supplier of extremely cheap goods if the Renminbi (the real name of the Yuan) were allowed to float.

In the short term (1-2 years):
1. Increase in prices in the US
2. Small correction in US balance of trade
3. Decrease in US GDP (~2% for a couple quarters due to increased prices; not enough to cause a recession)

In the long term:
1. Increased interest in India, Pakistan, and Indonesia as sources of cheap goods. All of these countries have far lower startup costs than China and allow more private control of companies.
2. China is forced to allow greater private control of companies (not sure on time scale of this; may be short term).
3. Investment focus shifts from China to India. This is a good thing for China, not a bad thing. 8-10% GDP growth is not sustainable.
4. China's economy stabilizes with a healthier 5% growth rate. Overtakes US GDP by 2040.
5. Indian GDP overtakes US GDP by 2050.
6. Indian GDP overtakes Chinese GDP by 2060. This is simply due to demography; India will have far more working people at that point and China will begin having major demographic issues around 2040. The one-child policy only works until a country goes through demographic transition. China should drop that policy within the next decade or two.

I think they should return to the Goldstandard!

(Knows nothing about economics)

I think they should return to the Goldstandard!

(Knows nothing about economics)

Then of course like a growing number of "doomsayers" have been rambling about. People could being to lose faith in the economy and a new world dark ages would come into place.

It would be an interesting and somewhat scary time. Either way, I'm prepared. :) I'm armed!

Marrakech is right. China would quickly lose its appeal as a supplier of extremely cheap goods if the Renminbi (the real name of the Yuan) were allowed to float.

In the short term (1-2 years):
1. Increase in prices in the US
2. Small correction in US balance of trade
3. Decrease in US GDP (~2% for a couple quarters due to increased prices; not enough to cause a recession)

In the long term:
1. Increased interest in India, Pakistan, and Indonesia as sources of cheap goods. All of these countries have far lower startup costs than China and allow more private control of companies.
2. China is forced to allow greater private control of companies (not sure on time scale of this; may be short term).
3. Investment focus shifts from China to India. This is a good thing for China, not a bad thing. 8-10% GDP growth is not sustainable.
4. China's economy stabilizes with a healthier 5% growth rate. Overtakes US GDP by 2040.
5. Indian GDP overtakes US GDP by 2050.
6. Indian GDP overtakes Chinese GDP by 2060. This is simply due to demography; India will have far more working people at that point and China will begin having major demographic issues around 2040. The one-child policy only works until a country goes through demographic transition. China should drop that policy within the next decade or two.

But the comparative advantage of China doesn't just stop at cheap labour and devalued currency. We also have two very good and safe starting points for overseas business wishing to enter China, namely Hong Kong and Taiwan. India cannot supply that. Also, with China opening up for over 20 years we are beginning to have the technical and legal expertise India is still lacking. We also have political stability, unlike the open hostility between India and Pakistan and the threat of terrorist attacks and anti-foreign sentiment in Indonesia. If the yuan was allowed to revalue bit by bit and let the market settle into the new equilibrium, after the revaluation China's economy could grow further rather than shrink.

Thanks Consilient Entities, Leonstein and others.

Leonstein,
3. The same advantages China has now: A huge labour force, a huge number of consumers, cheap labour (as well as new ones like more education and infrastructure) will remain.

How?

Already wages are rising in coastal China. Soon wage increases (if uncontrolled) will make the "cheap labor" thing unsustainable.

The whole manufacturing is based on endless supply of poor peasants willing to work for pi$$ poor wages in sweatshops without any rights that a laborer enjoys in developed countries. What happens when the people want to move up the value chain? Where will they move up to? Thanks to rampant piracy (http://www.iht.com/articles/2005/06/20/business/patent.php) and non-existent IP protection, there ain't much cutting edge tech industries or value added service industries that can absorb them.

That explains the mad rush by the commies to replicate the coastal model of development in inner areas - the forcible evacuation (http://www.washingtonpost.com/wp-dyn/content/article/2005/06/14/AR2005061401542.html) and pour money in reconstruction and infrastructure and have peasants work in sweatshops for pi$$ poor wages. Hence the commies will not revalue the Yuan or float it until they get to a stage where they are not dependant on exporting to US but create a wealthy enough middle class that will create in internal market which will substitute for the current US market. The problem is such a middle class will demand political reforms and would no longer tolerate the evacuation - reconstruction thing and the pi$$ poor wages with no labor rights racket going on now. Am I making sense?

Consilient Entities,

Good point about demographics that many miss.

2. China is forced to allow greater private control of companies (not sure on time scale of this; may be short term).

Commies would give economic freedom only as long as you do not ask for policial freedom. Hence complete economic freedom cannot be given since it would lead to individual independancy leading to aspirations for political freedom. Heck, the commies persist with huge non-performing SOE (state owned enterprises) despite the drag they are on the country. Plus the thing about the huge non-performing loans. Official figures state that the percentage of nonperforming loans is around 13 to 15 %. Official Chinese figures, that is, which we have to take with a mountain load of salt since there are no outside watchdog groups allowed. There was an article coupla years back at a state run Chinese news outlet, www.china.org.cn which quotes Dai Xianglong, governor of the central People's Bank of China, saying that 25.37 percent of the loans at the four biggest State-owned commercial banks were non-performing. (04-26-04). These loans have been disastrous and commies are postponing the disaster by , guess what, throwing MORE money at them.

http://www.carnegieendowment.org/publications/index.cfm?fa=view&id=16543
China's economy is still highly inefficient. The voracious maw of China's stateowned enterprises accounts for much of this drag. Between 1993 and 2000, more than 60 percent of all loans went to these state-owned behemoths. The country's notoriously high level of bad loans tells you how good an investment they have been: The Standard & Poor's rating agency currently estimates that China's banks have issued about $650 billion in bad loans, or about 40 percent of outstanding loans. If an economy growing at close to 10 percent a year generates bad loans on this scale, the misallocation of capital has to be gigantic. Although countries such as South Korea or Taiwan may not have had as much capital, they obtained considerably more growth for their investment buck. The same was true of Japan in its highgrowth phase. The same is true of India today.


All this indicates a problem which is hidden by the glitz in the coastal areas and the commies try to keep the momentum going by keeping the Yuan pegged to the dollar and assured exports to US markets by the cost competitveness.

But commie drones (citizens) will toe the line only as long as their economic livelihood is dependant on the state.

How long till the inevitable political reforms come and what will be the immediate and long term effects of that? Judging by the CCPs resolve in running tanks over students at Tianenmen, it is not likely they will be willing to give up their political control that easily. Heck, nobody ever gave up power voluntarily even when faced with certain defeat (Saddam :D )

See this article for another perspective
http://atimes01.atimes.com/atimes/China/GE21Ad02.html

Revaluation: A dangerous distraction?
By Sheetal K Chand

Washington's pressure on China to revalue its currency is strongly supported by countries such as those in the European Union whose currencies are appreciating relative to the US dollar. This is understandable, but is it appropriate? Or is the furor over the yuan simply a distraction that is diverting attention from fundamental flaws with the present dollar-based international monetary system - the biggest flaw being that such a system enables the dollar-issuing country to postpone adjustment?

The nostrum from Washington is unequivocal: the yuan should be market-determined, which will enable it to find its true competitive value at a presumably more appreciated level. But what do we mean by market determination? Has the euro, for instance, found its true competitive value?

Exchange rates are unlike ordinary commodity prices. An exchange rate is the price at which one money exchanges for another, and thus has a forward-looking, asset related dimension. If people want to hold more of the currency because they expect it to gain in value, or they wish to acquire more assets denominated in that currency, they will drive up its market value, irrespective of the level needed to clear purely trade-related demands for foreign currency. This results in a fundamental conflict between the requirements of production and trade, and asset holding considerations. This tension is masked when the exchange rate is fixed, with occasional open eruptions. However, floating the exchange rate does not resolve the inherent tension. It simply gives way to the more dominant asset-side influences.

One just has to view the widespread gyrations in the dollar exchange rates of many important currencies to find that they bear no relation to underlying production cost movements. For example, the appreciation of the euro of some 60% vis-a-vis the dollar over the past few years can in no way be justified by divergent productivity trends. If anything, the greater productivity improvements in the US should have moved exchange rates in the opposite direction.

Emerging economies can ill afford such wild gyrations of their exchange rates while they are trying to develop their productive sectors. They lack the hedging capabilities of mature industrial economies, whose firms are able to mix the currency composition of their production and financing activities so as to minimize the effects of exchange rate movements. A stable exchange rate environment is more conducive to economic development, but how can this be feasible if the asset side, especially involving volatile capital movements, is unregulated as in a free market?

But even if the yuan is not floated, should it not be revalued? Would this not ease the burden on other countries of the allegedly supercompetitive yuan? The answer to this question depends on how effective exchange rate realignments are in bringing about a redistribution of trade. One merely has to look at the bilateral trade balance between Japan and the US, which remains massively in favor of the former, despite a sustained secular appreciation of the yen.

Many studies demonstrate that the textbook paradigm of a revaluation changing the production and consumption mix does not hold. Market segmentation and pricing to market is widespread. Multinationals frequently account for a large part of trade flows, and organize supply chains to maximize their strategic advantage. A multinational that supplies a department store chain in the US with utensils, say, is unlikely to shift production from China to the US just because the yuan has appreciated even by a large amount. It would most likely absorb any reduction in profits that ensues. These will in any case have been cushioned through a reconfiguration of production and exploitation of the scope for cost savings on dollar-denominated imports such as raw materials. The revaluation of the yuan serves merely to increase profits of firms engaged in competing lines of production in the US and the EU, who will now find it easier to raise prices. This will, of course, be at the expense of their consumers.

The huge trade surplus that China has with the US may not be as problematic as it appears when sitting in Washington, since China has large deficits with many other countries. China has been accumulating huge foreign exchange reserves, but a significant part of these represent capital inflows. If one excludes them and also net foreign direct investment inflows, since the latter are also an asset exchange - namely, an infusion of foreign exchange to acquire a domestic asset representing future production capacity - the amount of reserve accumulation that represents purely mercantilist motives is likely to be small. How, then, can one conclude that the exchange rate is undervalued?

Even if China were to disappear from the face of the earth, the US deficit would not shrink: it would merely be shifted to other countries. The root cause of the problem is not deficient consumption on the part of China but excessive US consumption, and raising the prices of Chinese wares is not going to solve that problem. Household saving rates in the US are extremely low, hovering at the historically unprecedented level of less than 1% of GDP. Taking household fixed investments into account, mainly in residential housing, this sector is in substantial deficit. When combined with the large fiscal deficit - the corporate sector is more or less in balance - a big current account imbalance results. The only sound remedy is for households to save more and for the fiscal deficit to be substantially reduced.

Chairman Greenspan, while calling for a flexible yuan, is at the same time highly aware of the need to reduce domestic imbalances. He contends that the private sector will eventually reduce its excess consumption as its becomes more indebted, but that appropriate discretionary attempts will be needed to curb the fiscal deficits. He puts the responsibility for addressing the US balance of payments deficit on others. Yet his role has been central. The Fed has kept interest rates at historically low levels over a considerable period. After adjusting for taxation and inflation, interest rates are significantly negative in real terms. This encourages borrowing but discourages savings. The resulting stimulative effect on consumption and investment is further compounded by balance sheet effects.

Discounting the future expected stream of earnings on an asset at a much lower interest rate results in a huge upward asset revaluation. An obvious beneficiary has been the stock exchange, but so has real estate, with home values almost doubling in the past five years. This has also influenced the composition of investment in favor of less productive residential construction. Coupled with the remarkable ease with which traditionally illiquid assets such as housing can be tapped for their perceived higher equity value, it is not surprising that there has been a tidal wave of refinancing and second mortgages. The vast majority of Americans have enjoyed low interest rate-induced upward asset revaluations, which are bound to delay their resumption of saving. And yet a higher savings rate from the current generation is badly needed if they are to cope with retirement needs as they age. Setting real interest rates at a suitable positive level would have provided appropriate signals. But this has not been done.

The US economy is in a quandary and Greenspan is now gradually increasing interest rates at a "measured pace" so as to give transactors time to adjust and avoid precipitate decisions. It is a delicate balancing act, given that the economy has become so highly leveraged as a result of the incredibly low interest rates and expansive monetary policy. A sharp upward jerk in interest rates could bring the whole house of cards crashing down. However, increases in the Federal Funds rate of only 0.25% on each occasion appears to have resulted in little, if any, adjustment, judging from the continuing escalation in real estate prices. Much more adjustment is needed and this will be unavoidably painful. The temptation is to try to export as much of the required adjustment abroad as possible.

US authorities often argue that the reason for their large deficit is rapid growth in the US. If only the rest of the world would grow faster and at the same time appreciate their exchange rates vis-a-vis the dollar, much of the problem would disappear. Exports from the United States would boom, imports would be restrained, while profits would rise. The last is especially important to offset any adverse effects on investment of rising interest rates. The stimulus from higher trade would also make it easier to pursue fiscal retrenchment and counter skepticism over current budget improvement proposals.

However, this is wishful thinking. An appreciating exchange rate is contractionary for the EU, which, with its self-imposed restrictions on the stimulative use of fiscal policy, can do little to promote faster growth in the short to medium term. China is already growing rapidly and sucking in imports. Revaluing the yuan would dampen its growth and may not result in an increase in its imports. But even if higher growth elsewhere is not forthcoming, an appreciation of other currencies vis-a-vis the dollar is still a highly attractive alternative to engaging in painful domestic adjustment. A booming economy could then continue to live beyond its means financed by dollars which cost virtually nothing to produce. If the rest of the world holds these dollars, the day of reckoning is postponed, and if the dollar devalues the US obtains a free lunch. This is of course at the expense of others, such as China, which would suffer a massive capital loss on its holdings of dollar-denominated assets.

To ensure such gains, the US Congress is threatening punitive tariffs of 27.5% on imports from China if the yuan is not revalued. Since most of the imports are likely to occur anyway, the principal risk for China is that it would lose profits and revenue. A preemptive response on its part would be to impose duties on its exports. A better solution would be to internalize the environmental and other externality costs associated with the rapid growth of the productive sectors in China in the form of fees or taxes for conducting business. These would be reflected in higher export prices and help defuse perceptions that China's exports are too cheap, while keeping revenues at home and avoiding the capital loss that could result from freeing the yuan.

It is questionable whether any punitive tariffs that might be applied to China's exports, on the grounds that it has been manipulating its exchange rate, would be legal. China has operated its fixed exchange rate regime in full compliance with its obligations under the IMF's articles of agreement. To be accused of manipulation when all one is doing is maintaining an agreed peg appears bizarre. The real manipulation that is taking place involves the sequestration of the world's surpluses though the medium of the present dollar-based international monetary "non-system". It is time for a root-and-branch reform.

Dr Sheetal K Chand is an independent consultant and guest researcher at the Department of Economics, University of Oslo, Norway.


How true is the assertions in the article above ?


Dragons Bay,

Commies and political stability ...lol..where have I heard this before....Oh yeah Soviets in USSR !

Can't afford to "lose face", eh? :D

Political stability of China will go for a toss if Taiwan declares independance. :) Apart from that when people feel sufficiently satisfied with their economic livelihood (in another decade or so), let's see how "stable" the commies are when the drones get a mind of their own and demand political reforms.

-snip-
Firstly
What people said about giving up control is indeed correct. A freely floated currency (which I assume is the current alternative to what's happening now) negates all effectivity of fiscal policy ie the direct involvement of the Government in the Economy. Indeed, all positive effects on GDP are cancelled out by the appreciation of the Yuan, and the reactions of exports and imports. Additionally, crowding out of private investment will still occur.
The alternative here is then monetary policy, which offers much less direct control over what is happening. Eventually China will have to float the Renminbi, and I don't envy them, but I can see why they wouldn't want to rush it.
Secondly
You are proposing that the advantages the Chinese economy enjoys are not real, but merely created by unfair circumstances. That is of course unrealistic, and probably politically motivated ("commies"?). Piracy and so on are a problem, but not one the Chinese government is looking to stamp out, because it eliminates the need for importing entertainment etc, and probably for other reasons as well.
Chinese companies are in direct partnerships with many Western technology concerns, and so far Chinese industy has shown great potential for learning, copying and improving on foreign investment. I suspect that this will be the same.
If the Chinese play their cards right, just as wages start to rise, education will pick up, and the they will have to offer more skills than most 3rd world countries. Additionally, it costs a lot for Westerners to just relocate to India or so, so that would have to be factored in as well.
A large number of consumers remains, and will actually become more attractive as wages rise.
I added "cheap labour" because it sounded better to have one extra point in the list...but I suspect that labour from the inland will remain relatively cheap for some time - offering a rich base of consumers on the coast, and a poor base of workers inland. Not something I argee with, but attractive to foreign investment.

who will force China to revaluate the yuan before they are ready to do it?

and How will they foce China to do it...before they are ready?

I think China will revaluate the Yuan when they are sure it will not harm them.(not any time soon)

who will force China to revaluate the yuan before they are ready to do it?

and How will they foce China to do it...before they are ready?

I think China will revaluate the Yuan when they are sure it will not harm them.(not any time soon)
I have heard talk of the US threatening them with tariffs.

Dragons Bay,

Commies and political stability ...lol..where have I heard this before....Oh yeah Soviets in USSR !

Can't afford to "lose face", eh? :D

Political stability of China will go for a toss if Taiwan declares independance. :) Apart from that when people feel sufficiently satisfied with their economic livelihood (in another decade or so), let's see how "stable" the commies are when the drones get a mind of their own and demand political reforms.

Lol. No witty politics. China indeed has political stability. Well, it's regime doesn't look to be collapsing any moment or in the new future, does it? Even if Taiwan declares independence, it could only minimally affect the business attitude on the Mainland. We could have smooth political transition, no? Who knows. We'll see.

But for now, continue buying your goods from China! :D :D

Resident economists, please help me in understanding what will be effects of a Yuan revaluation.

What will be the immediate effects?

What will be the long term effects?

Will it increase the cost of goods exported thereby making chinese goods uncompetetive ?

What will happen to the value of the enormous US treasury bonds that China holds ?

My understanding is, if the Yuan revalues to a higher position, China would be getting fewer dollars in return for the bonds which would kinda lead to a situation where the Americans had their cake (cheap goods) and ate it too (lesser value of chinese held bonds). Is it correct?


No. Generally, american bonds are in the dollar (US), so the Yuan moving does not affect their value per se (of course, if inflation becomes a problem it would affect their value, and they can buy less yuan, but the bonds still have the same worth in dollar terms)

I have heard talk of the US threatening them with tariffs.
Hehe. Good one.
:D

Hehe. Good one.
:D
What won't Washington do? Remember Hawley-Smoot?

What won't Washington do? Remember Hawley-Smoot?
I didn't remember it, but I looked it up. Agreed, Politicians know shit about Economics (Bush tax-cuts...), but I still doubt that today Washington could hold their own against the entire corporate world.

I didn't remember it, but I looked it up. Agreed, Politicians know shit about Economics (Bush tax-cuts...), but I still doubt that today Washington could hold their own against the entire corporate world.
You're probably right. I think the threat was only made by a handful of senators. The lobbyists would go mad if that happened.

You're probably right. I think the threat was only made by a handful of senators. The lobbyists would go mad if that happened.

Yeah...if I remember correctly, I heard something like that. Something about a Senator getting blasted for that motion. Seems his state was getting a bunch of Chinese FDI that was boosting the local economy and people were pissed at the idea of the Chinese pulling the money out 'cause of the tarrifs.

Don't remember where I saw it or anything...pity.

Good thread, btw. Very interesting reading.

http://quote.bloomberg.com/apps/news?pid=10000006&sid=a04ESaRrTpcU&refer=home

China Ends Yuan Dollar Peg, Shifts to Currency Basket

July 21 (Bloomberg) -- China ended its decade-old peg to the dollar and said it will let the yuan fluctuate versus a basket of currencies, responding to criticism from the U.S. and Europe that its currency was undervalued.

The new yuan rate strengthens the currency by 2.1 percent to 8.11 per U.S. dollar immediately, the People's Bank of China said on its Web site. Until now, the yuan had been pegged at about 8.3 per dollar. The bank said it will continue to maintain a trading band of 0.3 percent.

The yen rose against the 16 most actively traded currencies and had its biggest gain against the dollar in 2 1/2 years. The yield on the 10-year Treasury note rose 5 basis points to 4.21 percent.

``This was the first step in a series of revaluations that we can expect in the coming years,'' said Paresh Upadhyaya, a currency portfolio manager who is part of a group that oversees $29 billion at Putnam Investments in Boston. ``They'll be gradual.'' Malaysia followed China's decision, abandoning its seven-year-old practice of pegging the ringgit to the dollar.

Letting the yuan strengthen may help President Hu Jintao control inflation by reducing the cost of imported products such as oil and copper, which are priced in dollars. It also gives the central bank, which has sold yuan to prevent the currency from appreciating, more scope to increase interest rates to cool an economy that expanded 9.5 percent in the second quarter.

`More Flexibility'

The yen gained against the dollar after China's decision, strengthening to 111.81. The Singapore dollar also gained and Treasury notes declined.

``What they're really doing is leaving the door open to further revaluations,'' said Jens Nordvig, a currency strategist at Goldman Sachs Group Inc. in New York. ``By not pegging the yuan to the dollar, it gives the Chinese more flexibility to engineer a gradual appreciation.''

Permitting the yuan to trade more freely would also answer criticism from the Bush administration and some members of the U.S. Congress that blame China's currency policy for a record trade deficit and the loss of 2.8 million manufacturing jobs.

The Treasury Department's twice-yearly review of exchange rate policies said last month that China needs to make the yuan more flexible or risk being branded a currency manipulator.

``China is now ready and should move without delay in a manner and magnitude that is sufficiently reflective of underlying market conditions,'' Snow told the Senate Finance Committee in Washington on June 23. ``Implementation of trade sanctions would lead to retaliatory policies against our exports, damaging the U.S. and global economy.''

Trade Deficit

The U.S. trade gap with China rose to a record $162 billion last year and the National Association of Manufacturers, a lobby group, expects it to grow to $225 billion this year.

Indiana Democratic Senator Evan Bayh and Maine Republican Senator Susan Collins presented legislation on June 23 that would let companies petition for duties on Chinese goods to compensate for government subsidies. The bill is one of more than a half- dozen in Congress that address what some lawmakers call China's unfair trade practices.

Currency Basket

Linking the yuan to a basket of currencies means China's currency wouldn't be tied so closely to swings in the dollar, said Adam Cole, a currency strategist at RBC Capital Markets Ltd. in London. The basket will probably be composed of the euro, yen and other Asian currencies as well as the dollar, he said.

``For instance, if we went through a prolonged period of dollar downward pressure then the yuan would feel all the pressure of that, but if it was using basket, then the move would be offset by other currencies doing better,'' said Cole. ``It's an easier way to manage a currency target.''

Singapore manages its currency by allowing it to fluctuate against a group of the nation's major trading partners. The Monetary Authority of Singapore, which reviews its policy every six months, hasn't disclosed the composition of the basket.

Investors have bet on a change in China's currency since 2002.

``If you let the exchange rate become more flexible, there is one clear direction it's going,'' said Marvin Barth, a currency strategist in London at Citigroup Inc., the world's largest bank. He spoke in an interview last month.

Investment in China

China's $1.6 trillion economy, which accounted for a 10th of world growth last year, has trebled in size since the yuan peg was introduced. Foreign direct investment jumped 14 percent to a record $60.6 billion in 2004, according to government figures. A year earlier, China surpassed the U.S. as the biggest recipient.

The People's Bank of China has to buy dollars that flow into the country to maintain the currency peg, adding yuan to the economy and diluting the impact of state lending curbs. The central bank spent $193 billion buying foreign currency in 2004, a 41 percent increase from a year earlier, it said on Feb. 28.

The central bank raised its lending and deposit rates on Oct. 28, the first increase in a decade, to complement limits on investment in property, steel and autos that have driven prices higher and strained power supplies.

``The next move is that people will estimate the stronger yuan's impact on the growth rate,'' said Steven Chang, vice president of global markets at State Street Bank & Trust Co. in Hong Kong. ``They may think the growth rate is going to slow down and wonder if it is going to be so much more positive for the Asian currencies.''

China is seeking to cap inflation at 4 percent this year from a peak of 5.3 percent in August. Inflation in 2005 is likely to slow to between 3.0 percent and 3.5 percent, the People's Bank of China said on June 14. The consumer price index climbed 1.8 percent in May from a year earlier, the National Bureau of Statistics said on June 13.


I am surprised at the lack of coverage in international media.

China's economy is starting to overheat, and soon the situation will go out of control and we could see declines in China's economy. I expect a decline in oil demand too. They have done too little too late to moderate growth and keep it at a reasonable path. Too much growth will lead to more inflation no matter what they do. The Chinese government also has the tendency of lying about growth figures. An article on that.. this article is a little bit dated.. but still the points stand....

http://www.forbes.com/2003/11/14/cz_rm_1114china.html

NEW YORK - If you've bet the farm on China's continued growth, then Thomas Rawski has a pertinent question for you. "Could China experience a big drop-off?" asks Rawski, professor of economics at the University of Pittsburgh. "The answer has to be yes."

Since companies from around the globe are rushing to China to pan for gold, we decided it was time to visit the Harvard-educated Rawski for his view. For the last 30 years, Sinologist Rawski has trawled secondary sources--everything from airline occupancy rates to little-read Chinese statistical trade journals--to verify or debunk official government claims about the Chinese economy. It's an imperfect art, he admits, judgments based on instinct and "built on fragments."

Two years ago, however, this mild-mannered professor made headlines around the world when he presented his case that the Chinese government had systematically falsified its gross domestic product data to hide an economic downturn that took place in 1998 and 1999. The government view, widely taken at face value, is that China has experienced uninterrupted growth since the late 1970s. By Rawski's reckoning, however, China's economy at best grew less than half the official GDP average of 7.6% between 1998 and 2001, and possibly even contracted during the crucial years of 1998 and 1999.

Many have reluctantly and to varying degrees come around to his view. Earlier this year, for example, Goldman Sachs (nyse: GS - news - people ) began its own calculations of China's GDP, and endorsed Rawski's take that the Chinese economy was caught in a downdraft in the late 1990s, estimating a 3.5% GDP growth rate for 1998 versus the 7.8% rate officially reported. (Goldman equally believes that China's vibrant but underreported service sector means its GDP can also be understated in some aspects.)

But the government's handling of the SARS epidemic earlier this year has also strengthened Rawski's case. "Now everybody knows the Chinese government suppressed health statistics until a Beijing physician pulled the plug on them," he says. "The only question now is whether [the government's suppression of bad news] spreads into the economics area as well as health. There is no question that falsification of economic data at the local and provincial level is widespread. We know this because in 1999 the National Bureau of Statistics, on the front page of a national daily, said the provincial statistics were 'cooked' . That was the term they used."

If you look at retail sales and energy reports, Rawski says, it's pretty clear the Chinese economy took a hard but short-term hit when the SARS crisis was raging. He believes "growth was pushed to near zero" for three months this summer. He equally believes, based on the U.S. experience during the 1918 influenza epidemic, that China will have resumed its torrid growth by the first quarter of 2004. "But I'm afraid the official stats went off the rails. Beijing City, for example, reported a 27% increase in GDP between the first and second quarter [when the city came to a virtual standstill]. That just did not happen."

Rawski says he sees a clouded picture going forward: a genuinely dynamic economy threatened by seriously "unpleasant elements." [B]China's banking sector is already a well-known danger zone; Chinese economists and technocrats are themselves writing that a "financial crisis"--their term--is possible. Of course, officially, the Chinese authorities will only admit to nonperforming loans of 30% at the leading state banks. Rawski says a little-known statistic ("rate of interest recovery") suggests that "50% is a better jumping-off point."

Intriguingly, Rawski says Chinese statisticians and technocrats not only provide his raw data but sometimes reveal in clever ways that their political masters are forcing them to cover up. As an example, he freely translates an article taken from his cluttered desk, written by "this smiling young lady" working in the "risk management department" at one of the leading banks. "For the four state-owned banks," writes the risk manager, "the figure for bad loans, which is released to outsiders, is near 30%." Says Rawski: "There's the flag. She's a technocrat and they told her to release the official figure, but 'released to outsiders' is the signal that says, 'I don't believe this and you better not believe it either.' Of course she knows the real figure."

But Rawski says a banking crisis, if it were to happen, would only be a symptom of a deeper malaise in the "bowels of the Chinese economy." Investment accounts for 40% of China's GDP but it is to a large extent controlled by the state, politically driven and inefficient. One trade article he came across suggested "50% or 60%" of the funds in some government projects were consumed before construction even began. Such investments, he says, "muck up the financial system, create losses, result in nonperforming loans, no product, no employment and the empty buildings which are a common feature of the Chinese landscape."

Research that Rawski conducted for the International Labor Office in Geneva led him to the conclusion that China has been experiencing a "jobless recovery" since the late 1990s, with a spike in urban unemployment aggravated by 100 million to 200 million farmers migrating towards the urban centers in search of work. That's why it is paramount that Beijing loosen its state-controlled stranglehold on investments. Such crowding-out prevents the dynamic private sector from accessing funds and creating jobs, and places unbearable pressures on the productive investments to create the 7% or 8% GDP growth Beijing needs to keep moving ahead.

But what about China's hugely productive direct foreign investment, which at last count stood at $53 billion? Impressive, Rawski says, but even such amounts get lost in a developing country the size and population of China.

So, we asked, who will lose out if China's structural problems come home to roost in a decade of slow or zero growth? Rawski responds that China's ruling authorities are genuine reformers, keenly aware of the weaknesses, and could manage the country through this difficult period. If they don't, then foreign firms that have set up production in China for the purpose of exporting abroad might even partially benefit from a slowdown, he says, provided there is stability. Nokia (nyse: NOK - news - people ) and Motorola (nyse: MOT - news - people ), with their huge China-based and export-focused manufacturing capacity, could be among this group, even though they are also selling hard within China's borders. These firms will pick up Chinese MBAs at lower cost and will find that their best people won't be getting as many outside job offers.

Companies banking heavily on the Chinese domestic market, however, could find themselves in trouble. General Motors (nyse: GM - news - people ), Ford Motor (nyse: F - news - people ) and DaimlerChrysler (nyse: DCX - news - people ) all have plans to import U.S.-made cars into China. "I think the auto industry could be in this [troubled] category," Rawski says. "I don't know who it is in the Chinese economy they think is going to buy more and more cars, but if some of my thoughts about the personal income statistics turn out to be on target, the combination of very rapid ramping up of production capacity and possible softness in income growth could create some unpleasant surprises."

General Motors, it should be noted, is predicting that China will account for 37% of the world's growth in new-car sales from 2002 to 2012. "I suspect," the professor says, "someone in GM is projecting a rather robust path for the Chinese economy. If that projection turns out to be optimistic, someone is going to get hurt."


The end of this overstated and exaggerated growth is near my friends.

http://www.falunnews.org.il/ch_ec/rf_002.shtml

"There are many devils in China's economy. Some are hiding, some are disguised---none can compare with the problems of its financial system. Even though the Chinese government puts on a good face on everything, the problems are very apparent anyway. As many economists as well as economic magazines and business-consulting firms point out, the financial system of China is facing a very difficult problem indeed."

This is a very serious problem for China, and I suggest we all look at it carefully.

China's economy is starting to overheat, and soon the situation will go out of control and we could see declines in China's economy. I expect a decline in oil demand too. They have done too little too late to moderate growth and keep it at a reasonable path. Too much growth will lead to more inflation no matter what they do.
While I agree that China's growth is supernormal and probably not sustainable as it stands now, I would like to point out to everyone

Theoretically it is possible to have growth rates of 100% and not overheat. it depends on the value of your Y*, ie the growth rate of GDP at full employment.
So high growth rates are not automatically unsustainable. But as I said, I reckon they are in this case.

China's recent move to devalue the Renminbi was not heavily covered because it was entirely inconsequential. Just because the RMB is not pegged "to the dollar" doesn't mean it's not pegged. The Chinese still have a fixed-rate currency that is at least 40% undervalued.

And Dragon Bay's comment that China is "politically stable" is ridiculous. Despite Xinhua and the party's extreme attempts to embargo all worthwhile news exports from China, things get through occasionally:

http://www.nytimes.com/2005/07/19/international/asia/19china.html

I believe most of China's potential investors read the New York Times.

Well well well, so we DID revalue the yuan...

http://news.ft.com/cms/s/ca3583f2-fa18-11d9-b092-00000e2511c8.html

Seems like there is some movement though.

A series of articles on the subject at FT

http://news.ft.com/world/renminbi

China ends renminbi’s decade-old peg to dollar

and more there

http://news.bbc.co.uk/2/hi/business/4703477.stm
China launches currency shake-up

Nothing catastrophic has happened until now...it appears very smooth. Since China's oil imports are very high, the Yuan appreciation against Dollar should help with imports.

If the Chinese RMB appreciates, it will be more expensive for them to buy foreign goods. Brilliant!! :D

Bump

Bump

Hi

Malaysia also removed the peg right? Was it a coordinated move or was it coincidence?

What is your opinion on why Malaysia had the peg and why it removed it now and what will be the effects ?

Thanks

Malaysia also removed the peg right? Was it a coordinated move or was it coincidence?


No idea, probably coordinated to flow with the Yuan. (Can't possibly be coincidence that we unpegged on the same day can it :D) Our country has been talking about revaluating the Ringgit this whole year, and thought we might actually repeg it at a lower value instead of letting it float. One idea was to repeg it on the Euro at one point.


What is your opinion on why Malaysia had the peg and why it removed it now and what will be the effects ?

Malaysia had the peg since 1998 during the economic crisis. Where our Prime Minister at that time (Mahatir) pegged the ringgit as to stop speculations when our ringgit was spiriling downwards similar to that of many other South East Asian nations. We are removing the peg considering over the last 2-3 years we had stable growth, good control over inflation rates and maybe its time to let natural economic forces take over.

As to it's effects, No idea, most speculate it would be a good thing. Hopefully it would be.
http://biz.thestar.com.my/news/story.asp?file=/2005/7/22/business/11563227&sec=business

I'm with Greenspan on this one.
The more they trade, the more their current account deficit might vary the harder they are gonna have to work to keep the Renminbi stable.
They can't keep doing that forever, no matter how many US$ they bought over the years.
So I'd expect these little steps to go on, and hopefully they'll reform their banking sector while that is happening.
And then watch them conquer the world for good... :D

Of course, this can only go on for so long until the Chinese people will realize they have money and really shitty domestic consumer goods and want *GASP!* imports.

Mercantilism died 200 year ago, folks. Current account balances aren't worth a thing if you can (or can't) back them up.

Of course, this can only go on for so long until the Chinese people will realize they have money and really shitty domestic consumer goods and want *GASP!* imports.

Mercantilism died 200 year ago, folks. Current account balances aren't worth a thing if you can (or can't) back them up.

Please elaborate.

Current account balances aren't worth a thing if you can (or can't) back them up.
Elaborate indeed.