Chinese Central Bank governor Zhou Xiaochuan announced the Chinese yuan will be kept at an appropriate level and no new strategy has been adopted, signaling a continuation of the current strategy. The yuan has been allowed to appreciate 21% against the U.S. dollar since the end of its peg in July 2005. However, the Central Bank has halted any gains since July 2008 signaling a de-facto return to the fixed currency regime.
This has not been lost on U.S. officials as Treasury Secretary Timothy Geithner last month called China a “currency manipulator”, a term not lobbed at the Chinese in the last four years.
Our comment: While the intention of China is to rejuvenate its slowing export market by providing traders with a stable currency, U.S. officials are afraid a return of a pegged yuan will hinder their attempts to rejuvenate their own economy. This can have potentially damaging affects to the U.S. economy as any movement in the dollar will be met with a synchronized movement in the yuan, reducing forex risk to Chinese traders but also limiting any reduction in the U.S. balance of payments. Under normal circumstances, a self stabilizing mechanism exists between a nation’s currency and balance of payments. If the volume of imports is significantly higher than exports, the supply of the country’s currency will be higher than normal thus reducing the value of its currency and making imports more expensive, correcting the initial problem. The reverse is also true for a nation with high exports. However, with the return of the yuan peg, this mechanism will no longer effectively work for China or the United States.
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{ 4 comments… read them below or add one }
When will the people in Washington realize how important this is to our economy, and that it needs to be corrected rather than “fixed”?
Larry Edelson Reply:
February 12th, 2009 at 12:26 pm
I believe that’s exactly what Geithner’s plan does.
So, China is basically using its reserves to maintain the peg. Doesn’t this create a huge risk down the line when things hit the fan in the US.
Larry Edelson Reply:
February 13th, 2009 at 2:33 pm
Not sure what you mean. But the Chinese know full well the dollar is going to be devalued. And since the yuan is linked to the dollar, that means the yuan will fall in value against the euro and other currencies such as the yen. It is how the Chinese can depreciate their currency and boost exports. It is how they can devalue their currency without coming out and saying that’s what they are doing. It’s very smart.
Larry, Seems to me that you and Martin have different opinions on the market and the dollar. How do the debates between you two go?
Larry Edelson Reply:
February 13th, 2009 at 2:38 pm
They’re friendly, and fun. Thanks for asking!
Larry,
With all due respect I think you will be proved wrong about imminent, roaring inflation. This economic cycle is different from those I have experienced in my 65 years. I seem to recall past recessions having been intentionally caused by the Fed tightening monetary policy to curb inflation. Then the Fed, once inflation was curbed, would intentionally ease monetary policy to allow expansion to resume.
This recession was not caused by Fed tightening but rather by too much debt. Most, if not all, of what the Fed has done in this down cycle has NOT been intentional. On the contrary, the Fed has been FORCED to make each of its moves and none of its moves have been effectual. Unfortunately, there is nothing the Fed can do to remove debt from the economy. Actually, the only thing government as a whole can do is move debt around kind of like Bernie Madoff did. And the result of government efforts will likely equal Mr. Madoff’s results; a giant ponzi scheme that comes crashing DOWN not up.
I think it will take years to wring enough debt out of the economy to allow growth to resume and even longer for inflation to become manifest.
Larry Edelson Reply:
February 26th, 2009 at 12:47 pm
That’s the conventional view. But if they devalue currencies, which I believe they will, then inflation could easily come roaring back. Not your typical inflation. But inflation caused by …
A. Devaluation and fears of further devaluations
B. Severe constraints on supplies of natural resources caused by a complete shutdown of new exploration and curtailed production
Furthermore, as the public begins to realize what you say in your last few sentences, that the government will come to be viewed as a “giant ponzi scheme” will in itself lead to a loss of confidence in government and fiat currencies, fanning the flames of devaluation — and reflation of asset prices.