Increased Yuan Trading Band
Without continued China economic growth at high levels, developed country economic growth and recovery is less likely. Currency exchange rates play a part in this.
On Saturday, April 14 China announced that it was doubling the 'trading band' on the Yuan/U.S.$ exchange rate by 0.5% to 1.0%. This was greeted by general enthusiasm, with reactions that included:
- Beijing must believe "that China's economy, although cooling, is sturdy enough to handle important, long-promised, structural reforms";
- reduced investor expectation of a steadily rising Yuan likely contributed to this change, where a larger trading band will not necessarily lead to a stronger currency;
- having a currency that trades with fewer restrictions enhances the chance of China succeeding in its vision of Shanghai being a global banking hub by 2020;
- China wants the Yuan to rival the U.S.$ as the global reserve currency;
- the Yuan currently is close to equilibrium, in circumstances where the Yuan has gained 30% since mid-2005 when it was de-pegged from the U.S.$;
- a more flexible Yuan helps China in 'turbulent times' by better enabling it to "guide the currency lower to aid exports";
- this announcement is coincident with "a combination of below-par Chinese growth data and renewed fears of contagion risks in the debt-plagued euro zone";
- this announcement "is all about macroeconomic flexibility in an economy that, by the end of the decade (2020), is likely to be on a growth trajectory towards 5 percent and where that flexibility is going to be needed even more";
- this announcement "sets the scene for better quality (China) growth in the next decade; and,
- economists believe China's "tightly controlled export and investment-driven growth model" is unsustainable.
The first of the referenced articles also reported that last month China gave permission to firms across China to pay for imports and exports in Yuan.
You can find these views, and more, in the first three of the five articles referenced at the end of this commentary.
Finally, in what seems to be nothing but a 'pat on China's back' statement on Saturday, Christine Lagarde, Managing Director of the International Monetary Fund, weighed in on China's policy change, saying:
"I would like to welcome this important step by the People's Bank of China to increase the flexibility of their currency. This underlines China's commitment to rebalance its economy toward domestic consumption and allow market forces to play a greater role in determining the level of the exchange rate."
China has a strong interest in the face of developed country economic difficulties in doing what it can to keep consumers spending in the developed countries. China's currency announcement in large part has to be about ensuring, to the extent such a thing is possible, that the U.S. (and other developed country) consumers continue to spend on products manufactured in China. Consider in this regard (see referenced articles and the European Central Bank website) that:
- China's factory sector that depends directly on foreign trade is estimated to employ 200 million people. That number is about 60% of both the U.S. and Eurozone total (including children) populations. The U.S. and Eurozone populations are almost identical in size, with each being home to about 330 million people, and,
- China's consumer consumption represents about 30% of its GDP, whereas U.S. consumer consumption is said to represent about 70% of its GDP. In Q4 2011 Eurozone consumer consumption appears to be in the order of 53%.
Neither China nor any other country does things altruistically. China is, to some degree, today in the 'catbird seat' in world economic terms. Arguably, this Chinese currency policy change will tend to contribute to:
- consumers in the developed countries continuing to spend at what likely are, and likely will prove to be, unsustainable levels; while
- buying China further time to build its own internal consumer base.
In other the words, this currency change in part can be seen as a China contribution to adding some glue to the can that keeps getting 'kicked down the road'.
Two other comments:
First, for China to allow its manufacturers to trade with their customers in Yuan is a material change from the currency control methodology that enabled the Chinese government to accumulated its vast horde of U.S. and other foreign currencies. This is an indicator that China is maturing as an economy, and may negatively impact the market for U.S. Treasuries. This is something to watch for; and,
Second, beware of growth statistics driven by percentages. Real (inflation excluded) growth is essential to the economic stability of any country whose population is growing. To the extent China's economic growth currently is an important engine that promotes growth in the developed countries, focus on the fact that perpetual growth at any given percentage rate is impossible - the 'magic' of compounding works in reverse. Stated differently:
- assume China's growth to be 8%. At that growth rate China's GDP would double in ten years. However, in absolute Yuan, that growth will arithmetically be twice as much in the tenth year as it was in the second year; and,
- extend the example to twenty years. In twenty years China's GDP at an 8% compound rate would have to realize growth in absolute Yuan that will arithmetically be four times as much in the twentieth year as it was in the second year.
China currency move nails hard landing risk coffin
Source: Reuters, Nick Edwards, April 15, 2012
Reading time: 4 minutes
by IMF Managing Director Christine Lagarde on the People's Bank of China
Exchange Rate Action
Source: International Monetary Fund, April 14, 2102
Reading time: 1 minute.