Monday, December 1, 2008 0 comments ++[ CLICK TO COMMENT ]++

China slightly de-values currency... temporary or not?

One of the most ominous developments would be if China de-values its currency. There is some concern, albeit a minority view right now, that a de-valuation of the Renminbi would be somewhat similar to the Smoot-Hawley tariff in 1930 (I referred to this possibility in this post.) The problem with the Smoot-Hawley tariff wasn't the tariff per se, but the numerous trade wars that it caused.

Well, according to MarketWatch, the Renminbi had a huge fall today:

China's currency staged a record loss against the U.S. dollar Monday, falling to the lower end of its daily trading limit, in what some analysts said is a policy shift as authorities let the yuan depreciate against the greenback in an effort to help bolster the decelerating economy.

The yuan eased to 6.8848 against the dollar, falling to its 0.5% trading limit, its lowest level since May. Against the dollar, the Chinese currency was at 6.8349 yuan Friday.

Since the Reminbi is managed by the Chinese government, any large move essentially means government approval of the policy. It's still too early and some think it will be temporary:

Morgan Stanley's Wang said he expects the weakening of the Chinese currency against the dollar to be temporary. A longer-term devaluation would run the risk of sparking capital outflows, copy-cat devaluations of regional currencies and renewed trade tensions with the European Union, the U.S. and other big trading partners.

He added fundamentals don't support a major softening of the yuan against the greenback, given China's large trade surplus.

As the quoted analyst says, a policy of permanent de-valuation may cause potential trade wars. I hope it never comes to that because it is going to end up in a world-wide disaster if that is the case.

The analyst also falls back to the notion that fundamentals won't support a lower currency hence this is a temporary weakening. But, obviously, it hasn't occurred to him that the exchange rate is set by the government. Even free-floating currencies can be manipulated by determined governments. The Japanese Yen has been thought by many to be undervalued for more than a decade. What happens with the Yen is that the Japanese government has been purposely buying US$ to weaken the Yen, in order to help their export-oriented economy (a misguided policy IMO that has led to massive deficits that impoverishes the future generation, and has led to massive bubbles elsewhere via the Yen carry-trade.)

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