March 01, 2007
Whither the Chinese Yuan?
The problem with writing blog posts in advance (I wrote most of this on the 25th) is that they may very well be rendered obsolete by the passage of events, especially when covering financial markets. Hopefully, in this case, the heightened uncertainty in emerging markets -- as well as the durability of the yen carry trade -- will not change the outlook for the CNY very much.
From IDEAglobal, a forex consultancy firm, in an electronic newsletter on "Asian Strategy for the European Session" (rec'd 9pm Pacific time on 2/28):
After the Shanghai stock market took a breather on Wed, following Tuesday's 8.8% plunge that contributed to a global selloff, the market was under the cosh anew on Thursday – down over 1% at present. Financial blue ships were sold down, aping the trend witnessed in their Hong Kong-listed H share counterparts. With the NPC kicking off next week and worries about anti-speculative measures as well as deposit/lending rate hikes by the PBoC still lurking in the background, we could well see further profit-taking, especially given the huge amount of inflows that the Chinese bourse has seen in the past year and expensive P/E ratios. However, the economy's fundamentals remain robust and after the profit-taking subsides, stability should return. Meanwhile, US lawmakers said on Wed that chances had improved this year for the US Congress to pass the Ryan-Hunter bill which would give American manufacturers a new tool to fight China’s exchange rate policy. However, an attorney for the China Currency Coalition has said that the Bush administration remains cool to the bill and that they didn’t really expect that they were going to endorse the legislation. Stay short the NDFs nevertheless in anticipation of a stepped up 7% p.a. pace of CNY appreciation which is not being priced in adequately yet.
In other words, the fundamentals are still the same fundamentals we saw a week ago: a burgeoning Chinese current account surplus expanding rapidly, and incipient protectionist pressure in the U.S. Hence, many eyes will still be trained on the trajectory of the Chinese yuan. As I've pointed out in other posts, the bilateral and the effective exchange rates can follow different paths -- and it is the effective exchange rate that matters.
However, forecasts are made for bilateral rates, so I thought it would be useful to show the dispersion in predictions.
Figure 1: Log actual CNY/USD nominal exchange rates (blue, monthly average of daily rates), forecasts from FX Forecasts, dated 2/21 (red squares); Deutsche Bank forecasts dated 2/22 (green triangles); and forward rates (black +). Source: IMF, International Financial Statistics online, FX4casts.com, Consensus Forecasts and Analysis of Currencies (March 2007); and Deutsche Bank, Exchange Rate Perspectives (February 22).
Since the graph shows logged values, a constant rate of appreciation is depicted as a straight line. Forwards predict continued appreciation at the relatively rapid pace experienced in the past few months (although beware using forwards as predictors [pdf]); interestingly DB predicts a deceleration in appreciation, while the consensus from FX4casts is for even more deceleration.
However, there is wide dispersion of the forecasts. Figure 2 depicts the highest and lowest values at the borders of the 95 percent band.
Figure 2: Log actual CNY/USD nominal exchange rates (blue, monthly average of daily rates), forecasts from FX Forecasts, dated 2/21 (red squares), and low/hi (95%) forecasts; Source: IMF, International Financial Statistics online, FX4casts.com, Consensus Forecasts and Analysis of Currencies (March 2007).
Posted by Menzie Chinn at March 1, 2007 12:03 PMdigg this | reddit
Buy Yuan Sell dollars, it's pretty simple, no?
Posted by: thefinancedude at March 1, 2007 01:07 PM
What bothers me is that our currency problems with China are caused by US currency mistakes not Chinese manipulations. How can China be manipulating their currency when they are pegged to the dollar? The theory is that they should allow their currency to "float" against the dollar to rise or fall to its "market" level, but those making such demands are actually attempting to use monetary policy to manipulate the dollar to gain a trade advantage. The only way to compete with China is to compete with China. All the currency manipulation will simply destroy wealth and hasten the inevitable.
Posted by: DickF at March 2, 2007 04:34 AM
The Yuan would appreciate substantially if the PBoC did not buy huge amounts of US$ denominated debt. About half of these purchases are made with freshly created Yuan. They thereby prevent the Yuan achieving a "market" price relative to the $. They are distorting the market, & everyone will eventually pay a price, especially the Chinese.
Posted by: algernon at March 3, 2007 08:42 PM
DickF: Currency values are the outcome of relative supplies and demands for monies, so both sides must be in some part responsible for the nominal bilateral exchange rate. The Chinese have some influence on both the nominal, and real, exchange rate given that purchasing power parity does not hold instantaneously (combined with extant capital controls). See my discussion of the monetary (and monetarist) approach to the balance of payments in this post on the 2007 ERP
Posted by: menzie chinn at March 4, 2007 03:07 PM
algernon and menzie,
My point is not that China does not buy and sell in the currency markets to maintain the value of its currency; floating exchange rates have made that a requirement if you are to maintain relative stability between currencies. My point is that China is keeping the Yuan relatively stable against the dollar and that the lowering of prices and the increase in prosperity in China are fiscal not monetary. The US is attempting to use monetary manipulations to correct for its fiscal problems such as an absurd tax structure and illogical and wasteful government regulations.
It is a pipe dream to believe that monetary manipulations will overcome the fiscal changes. What I hear from US government officials is that they want China to institute destructive monetary policies to restrict their growth and prosperity. This is the same bowl of swill that we are given when we are warned of "irrational exuberance" or "an overheated economy." All such terms are simply ways of saying we are having too much prosperity for our own good.
The world is moving forward in innovation and well-being, not because of these monetary manipulations, but in spite of them. In the aggregate the market is so powerful that it can even get around these monetary errors, even through all the pain, but that does not help the worker who loses his job or the businessman who is in bankruptcy.
Posted by: DickF at March 5, 2007 04:28 AM
thank for the post, the truth has finally hit me. The right point of view is that the chinese central bank is on the hook to lose hundreds of billions of dollars when they discover their holdings of us treasuries are not going to be worth as much yuan as they paid for them.
and when i say hundreds of billions i am not exaggerating, they have a trillion plus in us treasuries so a 15-20% eventual appreciation of the yuan is going to cost them 150-200 billion.
nice! (as Borat would say)
Posted by: kotika at March 5, 2007 09:09 AM
kotika: Chinese reserves do exceed USD 1 trillion; however, not all of that is in USD. Furthermore, not all of what they hold in USD are in Treasuries (although they are likely in Agencies, which are treated as close substitutes). See Brad Setser's blog for tracking of Chinese reserves.
Posted by: menzie chinn at March 5, 2007 11:05 AM
This could be the most important change in China's history and if passed will have a profound impact on Yuan/dollar exchange rates and trade.
The bill will be enacted next Friday, when the NPC closes its annual session.
The legislation underlines the fact that China has legally entered a market economy phase, after having started with a socialist economy, which upholds the state ownership of property, observers said. The country is expected to further accelerate unrestricted economic activities and promote the protection of individual property, they added.
The proposed law consists of 247 articles. In a chapter on basic principles, the law stipulates, "The property of the state, the collective, the individual and other obligees, is protected by law, and no units or individual may infringe upon it."
Thus the envisaged law is intended to allot equal importance to the protection of both private and state-owned property--as written in the Chinese Constitution.
Concerning private ownership, the planned law states that lawfully accumulated savings, investments and gains will be protected by law, and no entities or individual will be allowed to occupy, loot or destroy private property.
To prohibit the abuse of public power, the law would incorporate provisions on compensation for land expropriation and enforced evacuation, stipulating, "No entity shall expropriate collective-owned land by exceeding the limits of power or by violating procedures."
The law would allow for collective farmland to be subcontracted and for such subcontracts to be extended beyond their expiration--30 years for cultivated land--to help protect farmers' rights. Homeowners would be able to extend their leases automatically when they end, according to the proposed law.
The law on property rights was first proposed at the NPC's standing committee in December 2002. Due to strong opposition from Communist Party members--who stressed the importance of public ownership from the conventional standpoint of upholding socialist principles--the committee has held in-depth debates on the law an unprecedented seven times.
Posted by: DickF at March 10, 2007 06:02 AM