China Gives World a Lesson in Currency Policy

by John M. Curtis
(310) 204-8700

Copyright Janaury 1, 2012
All Rights Reserved.                                         

                Teaching the topsy-turvy currency market a lesson, China hinted they’d try to make the yuan a more convertible currency.   Western powers have criticized China for tightly controlling the yuan’s value, roughly at 15.3 cents to the U.S. dollar or 10.8 cents to the euro.  “If the highest standard of measurement is to have wholly unrestricted convertibility, then so many developed countries have not achieved 100 percent full convertibility,” said Zhou Xiaochuan, governor of China’s Central Bank.  China has resisted international pressure to float the yuan, a process that would no doubt drive the currency toward parity with the dollar and euro.  While it looks tempting, floating the yuan would hurt China’s economy and devastate foreign countires, heavily dependent on Chinese manufacturing.  Pricing China’s currency out of the manufacturing market would hurt the West.

            Western industries have relied on China’s stable, state-controlled currency to provide affordable manufacturing for many foreign companies.  Floating the yuan would no doubt hurt the bottom lines of many foreign corporations, currently manufacturing in China to maintain profitability and employment.  Investors involved in currency trading want China to float the yuan, leaving profits more dependent on today’s wild currency fluctuations.  While there’s money to be made in hedge and private equity funds, there’s much to be lost for China and the West in floating its yuan.  Hedge and private equity funds would make a killing trading an unrestricted Chinese currency.  China’s capital account, the broadest measure of trading goods and services, is still tightly controlled by Beijing.  Without tight controls, China worries that it couldn’t maintain consistent capital inflows and outflows.

            China regulates levels of foreign debt to maintain the yuan’s value, monitor cross-border deals to guard against illegal activities, e.g., money laundering, and resist money laundering and market speculation.  “Excluding the above three factors and judging from the 40-subitems set by the IMF, you may find that actually China is not that far from Capital Account convertibility,” said Zhou.  China says it want the yuan to trade within a wider band but limits its range to 0.5%, something infinitesimal compared to floating the yuan.  “The yuan’s trading band will be widened,” said Zhou, not admitting that it would be a tiny fraction of its current trading range.  Zhou admitted that 0.5% trading ban is miniscule compared to a real currency float.  “Compared with international markets, you may know that the 0.5% (daily trading band) is quite a small floating band,” said Zhou, discouraging the idea of open currency trading.

            When China experienced an inflation rate of 6.5% this year, Beijing raised interest rates three times to bring the rate down to 4.5%.  Federal Reserve Board Chairman Ben S. Bernanke has not been able to raise interest rates for the last four years dealing with a stubborn recession.  Unlike Zhou, Bernanke has been more concerned with deflation in the U.S., insisting on rock-bottom interest rates.  As the U.S. recession spread to China, it also helped ease inflationary pressures.  “Inflationary pressure is easing, and curbing inflation is not as urgent as 2011,” said Zhou.  China expects an inflation rate of between 4-5% in 2012, promising to raise interest rates more if inflation goes higher.  “But we should not lower our guard against inflation and must appropriately manage inflation expectations,” hinting that interest rates could be raised again if the economy begins to overheat.

            China’s currency manipulation should remind the European Union that floating currencies has inherent problems, not least of which is hyper-valuation.  Today’s Eurozone problems that threaten financial markets around the globe directly relate to unregulated currency markets.  Hitting a one-year low against the dollar, the euro remains a battered currency.  European Central Bank policymaker Christian Noyer believes that the euro could become the world’s strongest currency again if the Brussels-based EU can decide on new fiscal guidelines.  “In 10 years, maybe the euro will be the world’s number one currency,” said Noyer, cheerleading for the weak euro.  With so much European debt, it’s doubtful that the overvalued euro can help European economies improve.  When the euro celebrates its 10th anniversary Jan 1, 2011, questions remain on whether the common currency can survive.

            U.S. and European central banker like to blame the yuan for driving up inflation and killing jobs.  If the U.S. or EU wants to learn something from China, it involves fixing a stable price to the currency.  As long a traders drive up or down currencies, it’s going to be difficult to trade effectively with price-fixed currencies like the yuan.  Whether or not the euro survives, the U.S. must also deal with hyper-valued currency, leaving the U.S. and Europe unable to create private sector jobs.  “China has been always having relatively big scope to adjust its monetary policy,” said Zhou, leaving some to wonder whether they’re serious about adjusting the yuan.  Judging by how currency traders influence the euro and U.S. dollar, both should take a lesson from China that foreign exchanges need tighter controls.  Whatever happens to the yuan in 2012, it should not follow the dollar and euro.

  John M. Curtis writes politically neutral commentary analyzing spin in national and global news.  He's editor of OnlineColumnist.com.and author of Dodging the Bullet and Operation Charisma.       

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