China, the Yuan and Euro
The euro has declined about 0.75% this week. This seems fairly resilient, given that news stream that included the downgrade of a large French and Dutch bank, record premiums by Greece and Portugal and disappointing euro zone industrial order data.
Some have sought to link this resilience to China, which is at the heart of so many conspiracy theories these days. The argument is that China may have bought euros in size this week to influence (or do you say manipulate?) to prevent the basket to which it is linking the yuan (taking last weekend’s announcement at face value) from changing very much. In effect, revival of the basket approach may have coincided with an the PBOC buying euros again.
An advisor to the PBOC (Li Daokui) comments could be read to support such ideas. While acknowledging the risk of near-term weakness, Li said that the euro zone was going to survive and the euro itself would rebound on a medium and long-term. Greece and Portugal’s challenges are serious, he opined, but Spain, Italy and Ireland are not as vulnerable.
Li’s claim, however, that the yuan needs 10-15 years to become an international currency like dollar, yen, sterling and yen, is a bit odd. First, the yen is hardly an international currency, in terms of a reserve asset (about 3%), an invoicing currency (practically nil), or reference currency. Sterling is not much better. The euro stands out this regard and then of course the dollar. For the yuan to become as important as the yen does not seem far-fetched, though it presupposes a convertible currency, an open capital account and greater transparency than exists today.
Reform of the currency seems frustratingly slow and Li’s 10-15 year horizon may err on the early side. Last weekend’s announcement that caused ripples through the global markets was more than a nonevent, but seems only barely. The yuan initially strengthened 0.4% on Monday and that has really been it. It gained 0.5% for the week.
It comes down, in some respects, to what is meant by flexibility. When US officials call for the yuan to be more flexible, they seem to mean that the government should remove its rigid hand so the currency could appreciate. When Chinese officials say the will make the yuan more flexible, they seem to mean, more tolerant of two-way movement, but within a range.
The euphoria that initially greeted the Chinese announcement has faded. A former chief economist at the US Trade Commission said that China’s currency move made the Federal Reserve irrelevant. Other made similarly bold claims how it would be boost US exports, dampen Chinese inflation and boost commodity prices.
The 0.5% move this week needs to be understood within the context of the official band that allows the dollar-yuan rate to move 0.5% away from the reference rate.
A cautious attitude still seems to warranted. The proof of the pudding is in the eating, as the saying goes. Or to say the same thing, the magnitude and speed of the yuan’s move remains a "known unknown".