Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Why Would China Revalue the Yuan?


There are six main factors that could persuade Chinese authorities to allow it.

In my previous article, I responded to the question, "What if China Revalues?" from the point of view of the US economy. In this article, I'll approach the question from various Chinese standpoints in an effort to address the question, "Why Would China Revalue?"

Reasons a Revaluation of the RMB Is Becoming More Likely

There are six main factors that could persuade Chinese authorities to allow a revaluation of the Renminbi Yuan (CNY or RMB).

1. Overheating Chinese economy.

M2 money supply in February rose 25.5%YoY, well above the target rate of 17% set by the central bank. Loan growth for the first two months of 2010 has been well above central bank targets. Property values are skyrocketing. Retail sales rose 17.9% in the first two months from a year earlier while urban fixed-asset investment grew by 26.6%. This, despite the fact that the Chinese are officially targeting 8% GDP growth for 2010 -- the maximum rate that officials believe can be supported without inflation getting out of control.

Allowing the RMB to revalue will tend to moderate inflationary overheating in several ways. First, foreign investment in China will be made more expensive thereby moderating investment inflows. Second, revaluation will tend to dampen net inflows through the current account as exports will tend to moderate while imports will tend to rise. Third, revaluation will imply greater foreign competition in local product markets thereby placing a check on the ability of local producers to raise prices.

2. Sterilization policy becoming unwieldy.

In order to artificially keep the value of the US dollar up and the value of the CNY down, the Chinese central bank essentially "creates" CNY and purchase US dollars (USD) in the open market. All things being equal, this is a highly inflationary policy.

In order to avoid an explosion in the money supply and concomitant inflation, the Chinese central bank must engage in "sterilization" measures. Such measures include the sale of central bank notes to soak up the excess liquidity and also the raising of reserve requirements at banks to ensure that banks aren't able to lend out the liquidity that's deposited in banks. These policies have very important costs associated with them and create various distortions in the financial system.

Once it's understood that the USD-RMB peg obligates the Chinese central bank to either increase the money supply by fantastic amounts or issue astronomical quantities of Treasury notes, one can begin to understand how, at some point, the sheer size of these operations begins to pose serious challenges to the financial system. The Chinese central bank understands that there are limits to how far they can perpetuate this game.

3. Constrains Interest Rate Policy.

Given the overheating evident in the economy at various levels, the Chinese central bank will need to raise interest rates. However, comprehending the above points will allow readers to understand that the USD-RMB peg puts the central bank in a pickle. The basic dilemma is that raising interest rates without revaluing the CNY will tend to encourage an influx of hot money inflows. This aggravates inflationary pressures and/or the need to counter them with increasingly expensive and inefficient sterilization policies as described above.
< Previous
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Featured Videos