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Minyan Mailbag - The Renminbi Repeg Noise



Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

Note from author Mike Shedlock: This is a very lengthy article simply because there is a lot of noise floating around that needs to be dispelled. Those wishing to see the bottom line should look for the section "Let's Recap" towards the end of this article.

There was lots of commentary on the Renminbi this week from the World Economic Forum in Davos, Switzerland.

Specifically people everywhere were yapping about this:

A member of the monetary policy committee at the central bank, Yu Yongding, told journalists attending the forum, that given the dollar's recent weakness, "now is the time to revalue ... We need more flexibility. That means revaluation."

They were also yapping about these statements made by Chinese economist Fan Gang hyped up in this article:

If China Shuns Dollar, Look Out U.S. Bonds

"The U.S. dollar is no longer, in our opinion is no longer, (seen) as a stable currency and is devaluating all the time, and that's putting troubles all the time. So the real issue is how to change the regime from a U.S. dollar pegging to a more manageable reference, say euros, yen, dollars -- those kind of more diversified systems."

The U.S.$ bears were salivating once again as they do every time someone says something they want to hear.

A day later the news comes out that Yongding was speaking his personal opinion and that opinion carried little weight with the central bank's policy.

An official in the People's Bank of China's information office said Friday that Yu was an academic adviser, not an official, and that his opinion did not reflect official policy. "(Yu Yongding's) remarks are only his personal view, and the opinions of an academic. It does not represent the central bank's policy"

This was not the first time Yu's remarks created friction with the central bank. Yu previously came under pressure after he was quoted as telling an academic seminar that China was reducing its holdings of U.S. treasuries because of the sagging U.S. dollar. Those remarks triggered a steep sell-off of U.S. treasuries. Yu later insisted he was misquoted and that he had actually said that China had reduced its treasury holdings as a proportion of its rapidly growing foreign reserves.

U.S.$ bears everywhere have been expecting and waiting for China and Japan to sell their reserves crashing the U.S.$.

The current thought process looks something like this:

"It's only a matter of time before China dumps their U.S.$ reserves" and

"It's only a matter of time before China floats the RMB" and

"Look out below when they do".

Enquiring Minyans like to dig deeper however, and just might be asking two questions:

1) "Why isn't China selling those U.S.$?" rather than insisting that they soon will and

2) "When will China float the RMB? "

It just so happens that there appears to be a very good reason for China to hold on to its reserves. In fact, their U.S.$ reserves are not as high as one might think in the first place.

The following articles help explain the situation. They are not available in English, but those who speak Chinese can read the full reports here: Article 1; Article 2.

Those articles contain statements made by Zhou XiaoChuan, Governor of the People's Bank of China . When dealing with China one must separate official policy and statements made by those who set policy from those who do not. Zhou XiaoChuan sets policy, Yu Yongding does not. Perhaps after a second incident, we just might be hearing a little less from Yu Yongding. Interested Minyans can find a short bio about Zhou XiaoChuan, in English, here.

Most of us cannot read Chinese (myself included), so Minyans can thank my friend Yiwu for the translated highlights below.

The following text was translated from the above links by my friend Yiwu. Her comments are italicized in brackets (The bolding is mine).

Zhou said on Jan. 18th that "In 2004 China's foreign reserve increased a little fast, but the increase is not unreasonable. The year over year increase in China's foreign reserve grew at more than 50%, now standing at $609.9 billion." [This is total reserves not just U.S.$ reserves]. "We were keeping 3 months in reserve, but now the suggestion is to keep as much as 6 months of imports. So that means China needs to keep plenty of foreign reserves. Plus our imports have been increasing at an annual rate of 30%. Does that mean we should also increase our foreign reserves? This question is very complicated, and will influence our currency policy a lot."

Zhou also said that "China should be prepared for the reversal of foreign investment." Usually, foreign investors expect an annual return of 10%. [My own take, is if that expectation is not met that investment will leave. This might occur if the Chinese economy slows down or the U.S. increases their interest rate].

Zhou said "Foreign investment would have to leave sooner or later. China has to make sure to be able to meet their demand when they want their money back." [My own take, China is fully prepared for the exit of FDI in case China slows down].

Zhou said most of short-term foreign debt comes from the loan of foreign banks. And some of them are from foreign reserves of the enterprises. He thinks that this short-term foreign debt may very possibly have been changed into RMB now. So when conditions are right, "these short term debts might have to be exchanged back to foreign currency." [My read, disappointed that China is not going to revalue or float the RMB].

China has to prepare some foreign reserves to meet the possible reversal of foreign money, to prevent what had happened during Asian currency crisis from happening here in China". [Avoiding a currency crisis from happening in China is obviously a high priority.]

"Considering all of the above, the current foreign reserve of China ($609.9 billion and counting) is not high after all", Zhou said.

[The main points of Zhou's speech are to prepare for the possible expatriation of foreign investment and the avoidance of a potential currency crisis.]

I would like to thank Yiwu for that translation as well as her comments, and I have a few comments of my own to add.

According to the U.S. Treasury, China as of November 2004 held $191.1 billion in U.S. debt. That is not an enormous sum of money, all things considered. Given what we have learned, it would appear that the risk of China mass dumping their U.S.$ and treasury reserves in some sort of panic does not seem likely.

I have heard viewpoints stating that China must float the RMB by WTO agreements by 2007. I believe those viewpoints are incorrect.

Summary of U.S. - China Bilateral WTO Agreement

Regulators Promise Healthier Banking System

Foreign Banks in Post-WTO China: An Intermediate Assessment

Timetable Set for Lifting Restrictions on Foreign-Funded Banks

None of those articles mention anything about China needing to float by 2007. Enquiring Minyans do not give up so easily. Some might be wondering if there is any supportive evidence of that position from the United States. It just so happens there is:

China yuan peg doesn't break WTO rules: Zoellick

NEW YORK - U.S. Trade Representative Robert Zoellick said on Wednesday that he did not think CHINA's exchange rate policy violated World Trade Organisation (WTO) rules. 'There's really no WTO obligation not to have a fixed exchange rate,' he said before speaking to the Asia Society. His remarks appeared to squash U.S. manufacturers' hopes for the United States to challenge CHINA's exchange rate policy at the WTO.'You will recall the United States had a fixed exchange rate until 1971, when we were a member of the Gatt,' he said, referring to the predecessor organization to the WTO.

People must remember that China moves SLOWLY. Perhaps China floats the RMB by 2007 and perhaps they don't, but the key point is that China does not have to lift its peg by 2007 as is commonly believed. Quickly for China might mean a decade.

Minyans might also wish to consider the Asian principal of "saving face". This principle suggests that it would be highly unlikely for China to be pushed around and bow to publicly spoken external pressures from the U.S. or anyone else. Here is an article just published on January 24 2005 that discusses not only face saving, but gives three logical reason why China is not about to lift its U.S.$ peg:

Three Reasons Why China Will Not Lift Its U.S.$ Peg

One, China won't be pushed around. What Snow hasn't grasped is that a nascent superpower like China can't be seen as bowing to Washington.

Among China's 1.3 billion people, many U.S. policies like the invasion of Iraq are highly unpopular. Every time Snow pushes China publicly to let the yuan rise, he merely delays such a step. This issue requires thoughtful, behind-the-scenes economic diplomacy, not podium thumping for the world's television cameras.

Two, China's financial system is still fragile, and debt has everything to do with it. Its 9 percent growth and seemingly bottomless appetite for commodities masks the fact China's banking system remains hobbled by bad loans. That China refuses to revalue the yuan even slightly suggests things may be more precarious than we know. China also faces a dual challenge unprecedented in modern economics. Not only must it slow growth to avoid an inflationary boom-and-bust cycle, but it also needs to create jobs for hundreds of millions of people displaced by the transition from socialism to capitalism. Since the currency peg is a key source of stability, it won't go away anytime soon, no matter what the U.S. says.

Three, the U.S. has its own public relations woes. When finance ministers from the Group of Seven industrial nations meet in London next month, the U.S. currency is likely to attract more criticism than China's. The dollar's weakness against the euro is irking Europeans, who fear slowing growth.

What Snow may not realize is that the more the dollar falls, the less likely a Chinese revaluation becomes. China grows more competitive along with the U.S. as the dollar drops. Also, the U.S. must consider how Japan will respond to all this. If Tokyo starts selling yen to boost the dollar, China, fearing a loss of competitiveness to Japan, will be slower to let the yuan rise.

Also of note are Malaysia's and Hong Kong's peg to the U.S.$.

Getting a pass on U.S. pressure are Malaysia and Hong Kong, two economies better prepared to float their currencies than China. ... the reason why exposes the White House's motivation -- politics, and nothing but.

Specifically Prime Minister Abdullah Ahmad Badawi of Malaysia had this to say about lifting its peg:

``There is no timeframe but, as I've said before, no regulation is cast in stone,'' a calm Abdullah said recently. ``The peg will remain for the time being. There is no change at this point in time.'' It echoed recent comments by his predecessor, Mahathir Mohamad, who pegged the ringgit at 3.8 to the dollar in 1998 to curb speculation during the Asian financial crisis.

Here is another article that mentions face saving:

Zhu Guangyao, head of the Finance Ministry's international department told a business forum that "For any country the exchange rate issue should be decided by the sovereign state." That appears to me to be a polite way of telling Bush and Snow to go take a hike. Somehow we have not gotten the message.

The following is a not so polite way of telling Bush and Snow to take a hike.

China´s Ruogo asserts autonomy in yuan decisions.

Li Ruogo, deputy governor of the Chinese central bank, told global economic pundits that the country was fully capable of handling the transition to a floating exchange rate by itself. Ruogo said China alone would decide when the time was right to dismantle the peg that keeps the yuan fixed to the U.S. dollar, a move some economic commentators believe is necessary to correct growing imbalances in the global economy. "Leave this issue (of floating the yuan) to the Chinese people and the Chinese government. We will certainly figure out what is the most suitable approach for China's economic development," he said in a trenchant address to business leaders at the World Economic Forum here.

The deputy governor of the People's Bank of China said foreign monetary policy commentators were generally ignorant of economic conditions within the country. Their advice would therefore have little bearing on when the dollar peg would be removed. "Outsiders don't know what exactly is happening in China. We are happy to listen (to outside advice) but don't ask us to practice what you say," he said. "If we think it is correct (to float the currency) we'll go ahead, and if we think the time is not correct we will wait," regardless of "how heavy the outside pressure is." Ruogo rubbished arguments that allowing the yuan to rise in value against the U.S. dollar would reduce the U.S.' burgeoning trade deficit, regarded by many as the main threat to global economic stability

"The idea that China has the key to the balance of the whole world's economy is totally wrong. The imbalances are attributable to many reasons, but not whether the yuan exchange rate is flexible or not flexible," he said. The deputy governor reiterated Deputy Prime Minister Huang Ju's pledge to allow the yuan to float freely at some point, but not before structural improvements and banking reform were enacted.

My friend Yiwu offers this comment: [Li GuoGu (not Li Ruogo) is the right hand man of Zhou XiaoChuan. So what he said definitely reflects the official government position. The U.S. should not expect to make China's $1.4 trillion economy a scapegoat for the $20 trillion combined economy of the U.S. and EU.]

China: No Rush to Reform Forex Regime

Huang Ju, China's vice premier in charge of financial and banking issues, told the Davos gathering that before acting on exchange rates, China needs to make further progress on cleaning up its ailing banking system and opening up its capital markets. "We do not have a specific time frame," Huang said. "To improve the exchange rate mechanism, we have to maintain the exchange rate at a reasonably stable level." He added any adjustment to the currency peg would come in a "gradual, steadfast" manner.

My friend Yiwu offers this comment: [It is completely irresponsible for the U.S. and EU to push China to float the RMB knowing how bad the Chinese financial sector is. What the U.S. and EU are trying to do to China is similar to what happened to Japan with the Plaza Accord. China would never put itself in that situation. BTW, Huang Ju is one of the Nine members of the Standing Committee of the Political Bureau (Political Bureau is highest leading body of Chinese government), and the immediate boss of Zhou XiaoChuan.]

Finally let's look at one more article. This one from the Northern Trust.


[There are some nice charts in the following link with snips in italic below]

Now there's renewed talk out of Washington suggesting that the yuan should be revalued at the earliest possible time, while some economists are digging out their overheating scenarios. All this is happening while Beijing digs in its heels and says everything's fine and the renminbi yuan rate is not going anywhere for the moment. Now that the discussion has started up again, which side has the stronger argument?

After weighing both sides, there is some validity in Beijing's claim that things are under control. First off, inflation has decreased markedly over the last half of the year, ending 2004 at a comfortable 2.4% on-the-year. This accomplishment alone implies some success in conquering the overheating issue, even though the CPI is a compiled statistic gathered from state and regional sources that may or may not be a reasonable representation of reality. However, the more convincing argument comes from figures out of the People's Bank of China (PBoC), namely money supply. This series shows a significant drop-off starting in Q2 2004, and only turning around as of last quarter. M2 data are also generally more accurate as they are maintained from the PBoC.

At the G-7 meeting during the first weekend in February, the topic of the yuan will be brought up along with the weakening dollar, and the Chinese renminbi will likely be part of the U.S. response to criticisms about the faltering greenback. Understandably it would be dangerous for China to change its currency regime in the middle of a slowdown, assuming one is on the way, as a revaluation would exacerbate a slowing economy significantly. More importantly, there's no reason to believe Beijing will be persuaded by the industrialized nation's complaints and consider a near-term shift in the value of its currency. Strong words from the industrialized nations have rarely made much of an impact on China's internal decision making process, and right now Beijing's numbers are making the most convincing argument of all.

Let's Recap

1) There appear to be good reasons for China holding U.S.$ reserves and those reserves do not seem extraordinarily large.

2) Hot money flowing into China in hopes of making a quick killing on a currency repeg or float will likely delay that outcome.

3) Fundamentals such as money supply, slowing growth, and inflation do not seem to favor floating the RMB at this time.

4) Chinese banks might not be in a position to take the stress of floating the RMB at this time, even if other factors were conducive.

5) The Chinese central bank does not want to trigger a currency crisis by floating the RMB too soon.

6) There is no WTO requirement for China to float the RMB by 2007 as is commonly believed.

7) "Snowtalk" is counterproductive for two reasons: It encourages more hot money to flow into China and it violates the concept of "face saving"

8) Those speaking with authority seem to be offering clear, consistent and defensible positions.

9) Huang Ju, Zhou XiaoChuan, and Li GuoGu speak from positions of authority. They have made their positions clear: China will react in due time, as China sees fit, and outside pressure is both counterproductive and unwelcome. The world, however, does not seem to be listening.

10) Noise is everywhere. Most of that yapping carries no official weight. Statements made Fan Gang, Yu Yongding, and others carry no official weight. Yet those are the stories that have been repeatedly over-hyped by the press with titles like "If China Shuns Dollar, Look Out U.S. Bonds". This has been going on for months. More and more people are reacting to the hype by shorting treasuries. A short squeeze in the 10 year treasury might even be in the making.

The logical conclusion, at least in this Minyan's mind, is that China will act as it sees fit in its own timeframe.

Public pressure coming from the U.S. will only delay the process.
China will "eventually" float, but eventually might be a long time.

Perhaps some clues can be obtained by monitoring the status of short term foreign currency holdings in addition to statements made by those in authority such as Huang Ju, Zhou XiaoChuan, and Li GuoGu.

The U.S.$ may or may not keep falling, but the hopes of the U.S.$ bears of sudden massive selling of dollars by China does not seem warranted at this time. We can talk about Japan in another article later. This one is probably too long already! In the meantime, Treasury Secretary Snow should be very careful of what he asks. When China does float the RMB, it will come at a time of China's choosing not ours. When that happens, I am willing to hazard a guess we will not be pleased with the outcome.

I hope this article helped filter through the noise instead of adding to it!

Minyan Mike Shedlock


No positions in stocks mentioned.

Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at

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