China’s contribution to the euro-zone’s would-be 1 trillion euro bail-out fund, the European Financial Stability Facility (EFSF), will likely be more token than substantive. The head of the fund, Klaus Regling, is in Beijing with his collecting tin, but while he will find his hosts wishing to be internationally cooperative, he will also find them risk-adverse and somewhat divided on how much China should contribute. Some would prefer to contribute through the IMF, where China could extract some political return, which will also be expected but more difficult to achieve if Beijing contributes directly to the EFSF. The are also still some burned fingers in Beijing from earlier foreign investments to diversify its foreign exchange reserves from U.S. government paper. The unresolved details of Europe’s plan gives Beijing the necessary excuse not to be rushed into committing itself to anything just yet and the time to work on some quid pro quo, probably on the trade and technology transfer fronts.
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Europe is getting the same public message from Beijing on yuan revaluation as the U.S.: “Back off and let us deal with it in our own time.”
Prime Minister Wen Jiabao told E.U. officials in Brussels (left) that a big shift in the value of the Chinese currency could create “social and economic turbulence” in China (exporters going bust, migrant workers returning home, Party’s legitimacy undermined…OK, so he didn’t actually say the last bit). But Wen did say that such dislocation would be bad for the world. China was still intending to make its exchange rate regime more flexible, but would do so to its own timetable, Wen said. (Full text of speech)
That is the oft-repeated line that is overtaxing the patience of China’s critics in the E.U., just as it is their counterparts in the U.S. who accuse China of keeping the value of the currency low to help Chinese exporters. Yet, ahead of the annual meetings of the IMF and the World Bank, Wen has also expressed China’s support for the euro, which has gained more than 30% against the yuan since 2001 and 13% since June. And the stops on his European tour are instructive, Greece, Italy and Belgium among them, three of the eurozone’s most indebted countries, but whose paper, along with that of other euro danger cases, Ireland, Spain and Portugal, Wen says, China will readily buy when it starts being issued again.
China doesn’t want a euro crisis, or worse, a collapse of the currency regime for two reasons. First, it would devastate a key export market where recovery, where it has happened, is sluggish at best. Second, it would leave the dollar as the unchallenged world currency, giving Washington an unpalatable degree of control over the global financial system for Beijing’s taste. So it needs a euro robust enough to be an alternative to the dollar, and will do what it needs to prop it up. Nor will Beijing be sorry to be holding high-yielding Euro sovereign debt, providing the euro survives its current crisis unscathed. The question is, will it. China may have a political strategy for the euro, and the euro itself may be a political creation, but the currency still has an economic dimension, too.
We have long argued that China would allow its currency to appreciate, as much of the rest of the world is demanding and which in the long-term is in its own economic interest, but that it would do so at a time of its own choosing. That indeed has been Beijing’s public position regardless of the volume of the rhetoric coming out of Washington and Brussels. Today’s unexpected announcement by the People’s Central Bank of China that it will return to its pre-financial crisis managed floating exchange rate regime introduced in 2005 to replace the yuan’s peg to the dollar but suspended in July 2008 following the onset of the global financial crisis, is more style than substance, though there is some substance there.
No one should think, though, that Beijing is letting the currency float freely. The central bank is explicit that there will be no ‘large-scale appreciation of the yuan” and that the previously used narrow bands within which the currency can move will be re-instituted. That means that any appreciation in the exchange rate is likely to be modest and gradual. And while the announcement comes ahead of the G20 summit in Toronto, with the intention, we assume, of taking some of the sting out of the issue there, there is no indication of the timetable by which it will be implemented. We don’t expect the central bank to be in much of a rush. Nor do we think that all China’s economic policymakers are yet convinced of the solidity of global economic recovery that allowing the yuan to appreciate would imply and which the central bank cites as a justification for the policy switch.
There is also an opaque reference in the central bank’s statement that “continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies”. While no one has known exactly what the composition of the reference basket was, beyond being overwhelmingly U.S. dollars, given the changing nature of China’s trade over the past couple of years, the new mix could have a material effect on the politically sensitive U.S. dollar-yuan rate that would mean that rate not moving much, and the yuan-euro rate moving more, a combination that wouldn’t appease the increasingly bellicose critics of China in the U.S. Congress. If the euro remains weak, the yuan could conceivably depreciate against the dollar, which would really put the cat among the pigeons.