Thursday, July 21, 2005

Revaluation really was imminent

Wow, the yuan-dollar peg is now a moving yuan-basket peg. Only a 2% move for now, but stay tuned for further developments. The 10 yr yield is up to 4.28 today, so 10y treasuries lost about 2.5% in value in a single day. For some historical perspective, see here for a graph of dollar-yen in the wake of the Plaza Accord -- the dollar dropped by more than a factor of 2-3 against the yen in the following decade.

BEIJING, July 21 - Following months of political pressure, China today revalued the yuan to 8.11 for every dollar, scrapping a decade-long peg to the currency in favor of a more flexible band using a "basket of currencies."

China's announcement, which has been anticipated and debated by economists and government leaders for months, is the first time in a decade that China has raised the value of its currency, also known as the renminbi, effectively making the yuan and exports more expensive against the United States dollar.

The move represents China's first step toward the more flexible exchange rate that the United States, Europe and many other countries have called for in recently. Until the announcement, the yuan sold for 8.27 for every dollar, a rate that has remain unchanged since 1998.

The change falls far short of the 10 percent to 15 percent revaluation demanded by many in Washington, where the Bush Administration and Congressional leaders have been calling for a higher yuan, in part to alleviate America's growing trade deficit with China.


Dave Bacon said...

So what happens next? Bond yeilds serge and... Will this be the event which eventually triggers a burst in the house bubble?

steve said...

Yes, this may eventually burst the housing bubble here.

The contrarian point of view is that China still needs a place to park its surpluses, and where can they go other than US fixed income markets?

If you want to see dramatic, forward looking effects, check out the dollar-won and Taiwan dollar exchange rates. They had moved almost 10% earlier this morning. The Korean and Taiwanese currencies will appreciate as the yuan does. A few months ago I bought a bunch of iShares tracking stocks for Korea, HK and Taiwan, thinking of it as a long-term bet on revaluation. Looks like it is paying off sooner than I thought.

Historically, you can see that yen-dollar moved by a factor of 2 after the old Bretton Woods regime collapsed (I have data in postings in 2004). I expect the same to happen with dollar vs. basket of Asian currencies over the next decade or so. There is no other way to have "factor-price equilibration" between labor in China and the rest of the world (same as in Japan before).

steve said...

Oops, I misread the FX graph - the won/TWD move was only a couple of percent today...

PS said...

10% drop in USD would have wiped out Warren Buffet once again :)

Factor-price equilibration between China and teh rest of the world maybe fixed by a new "iron-bamboo" curtain... the question is how willing the world governments are in appeasing their electorate, recieving fat check donations from multinational corporations at the same time...

Anonymous said...

steve wrote, There is no other way to have "factor-price equilibration" between labor in China and the rest of the world (same as in Japan before).

Is there empirical evidence that such equilibration occurs in a reasonable amount of time?

IIRC PPP might not equilibrate for decades or longer (though PPP is not the same as a direct index for the price of a factor of production).

Carson Chow said...


It seems to me that on the short term, it is in the US interest (at least Walmart's) to keep the peg as it is. What is the motivation of this administration to pressure China to remove the peg? They've shown no concern over the deficit. Who's applying the pressure? I thought US businesses like outsourcing.


steve said...

It's possible that equilibration won't occur, but often that is because of trade barriers and other distortions.

Carson: Schumer had the votes to levy a 30% tariff on Chinese goods. BushCo were able to forestall a vote by leaking to them that reval was imminent (see my earlier post). There is pretty strong protectionist sentiment that is putting pressure on China to revalue (same as before Plaza Accords). So I see a lot of similarity between what happened before with yen-dollar and what will happen in the next decade with dollar vs basket of Asian currencies (yuan, won, NT dollar, etc.)

It is in China's interest to gradually increase the value of their currency: it will help in acquisition of foreign companies, technology, etc. Also, they have a huge potential loss on the Treasuries they are holding if there is a drastic reval. By letting their currency adjust over time they reduce the amount of FX intervention required (reducing the amount of Treasuries they need to buy), etc.

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