For a wide variety of reasons, the vast majority of which remain diplomatically unstated, China would like to get away from the US dollar as the reference point of choice for measuring the yuan, also known as the renminbi. A recent speech by Hu Xiaolian, the Deputy Governor of the People’s Bank of China (the Chinese Central Bank), released on July 22 talks in relatively coded terms about this very point. Hu points out that while it is common practice for everyone to focus on the yuan dollar relationship, China has been managing a floating exchange rate against a basket of currencies, not just the dollar, since 1994.
That is a bit of an overstatement. According to RIETI, the Research Institute of Economy, Trade & Industry, China’s transition to a floating exchange rate system began with the “yuan reform” implemented precisely five years ago (July 2005), when it moved from a conventional dollar peg to a managed floating rate system. However, as the RETI experts point out, the Chinese emphasis was always on the “managed” part, rather than on the “floating” part of this managed, floating basket of currencies. “Managed” here means that the Chinese monetary authorities went stamping into the market on a daily basis, adjusting, adjusting, adjusting.
Hu’s latest speech picks up on the 2005 reform and points out that since then, the central bank has tried to couch all its communications about the value of the yuan with reference to its managed basket of currencies, rather than simply with reference to the dollar. It has had precious little success in getting the public to take this comparison seriously, not least because the composition of the basket is opaque and when you have one currency shifting gently in relation to a number of other currencies (Hu talks only about the basket consisting of the currencies of major trading partners, on a trade weighted basis), then you have a very complex dance, the implications of which would not be exactly clear 99% of the time even if you knew the exact composition of the basket and the rules for revaluing the yuan in relation to it. By way of contrast, the implications of an undervalued yuan against the dollar are immediately obvious. Chinese goods become very attractive to US consumers and US imported goods start looking very expensive to Chinese. This is why the US gets into a froth every now and again on the subject of Chinese currency manipulation.
In classic fashion in Hu’s paper, while she is very ready to speak openly of “the necessity for China to make more efforts to improve the exchange rate regime based on market supply and demand… with reference to a basket of currencies”, there is no mention at all of the arithmetic by which such a feat will be achieved. Hu prefers to take a very broad brush approach and to keep matters at the most general level of macro economic theory. For example: “The Balance of Payment balance and the current account balance in particular, are the basis for equilibrium exchange rate analysis. An internationally accepted indicator is the current account balance to GDP ratio (as used by the International Monetary Fund).”
Translated into the irate language of US Senators, China is running a massive trade surplus, aggravated by a yuan that is being maintained at an artificially low level against the US dollar, howsoever the Chinese monetary authorities wave their mysterious currency basket over the yuan. It will be interesting to see if China’s desire to upgrade the visibility of its currency basket comparator leads it to release more detailed information on said basket...
Further reading on China and currency risk
- Interdependence of National and International Markets: The Foreign Information Transmission (FIT) Model, by Boulis Ibrahim and Janusz Brzeszczynski
- Hedging Foreign Exchange Risk—Case Studies and Strategies [checklist]
- Managing Liquidity in China—Challenging Times, by Marlene Wittman
- China and the Global Financial Crisis, by Linda Yueh
Tags: basket of currencies , China , currency , Hu Xiaolian , People's Bank of China , Renminbi , US dollar , Yuan