China’s policymakers may not be too sorry, for once, to see the yuan hit its highest value against the U.S. dollar since 1993. This week alone has seen the currency rise 0.7% against the greenback, its largest weekly jump in four years. By the standards that Beijing has imposed on the tight management of its currency, and its resolute opposition to letting the yuan appreciate except to its own timetable, it is a dramatic rise.
Long-term, it has always been in China’s interest (and policymakers’ plans) to let the currency appreciate towards market-driven levels in order to support the effort to reorient the economy away from export-led growth and towards domestic consumption. But a number of short-term factors have come together to make a stronger yuan desirable now.
It will help in the fight against inflation, which hit a three year high of 6.5% in July. It will slow the accumulation of dollar-denominated foreign-exchange reserves at a time when Chinese officials worry about the erosion of the their value in the face of the U.S. deficit debacle, and July’s trade surplus, the largest in two years, will swell them further. It, up to a point, would also pre-empt further inflationary impact on China of a further round of quantitative easing in the U.S., should the U.S. Federal Reserve may good on some hints that that might be necessary if U.S. GDP growth remains tepid, and, even more intangibly, it stocks up some international goodwill for Beijing as it makes China look to be a responsible team player in the face of a potential ‘double-dip’ global economic slowdown.
Most important of all, as far as the internal debate on the currency goes, appreciation would not be happening in the face of foreign, particularly U.S., pressure to let it happen. Whether there is a fundamental shift towards liberalizing China’s exchange rate policy about to happen, or, as seems more likely to us, a cautious step in that direction through, say, widening the bands within which the yuan is allowed to fluctuate each day, it won’t come without some cost to the rest of the world. The dollar, by definition, would fall and U.S. Treasury yields rise, if not disruptively; China would export some of its inflation. Many of these effects would, of course, net out across the global economy, such is the arithmetic of current accounts. How smoothly that would go depends as much as anything on what progress China can make in liberalizing its domestic financial markets. That is the biggest missing piece in making the arithmetic of canceling out the global imbalances work out.