China Plays Nice?

For the better part of the last two years, the People’s Bank of China (PBOC) has kept the Yuan pegged to the dollar at roughly 6.83 RMB to 1 USD. Contrary to popular opinion that Chinese officials simply threw a dart on a board and arrived at this number, this was part of China’s plan to fight off the negative impacts of the recession.

Of course, other nations weren’t too happy with the peg. Some consider the Yuan to be severely undervalued, which gives China an unfair competitive advantage in trade. You see, a cheaper currency boosts a nation’s exports since it makes them more affordable compared to those from other countries. Is anyone really surprised that China’s been hitting double-digit growth recently?

One nation in particular who has made vocal their concerns is the US. In recent months, US officials have tried to pressure China into allowing the Yuan to appreciate. I wrote about this in one of my older entries and it seems that Chinese officials are finally giving in to the pressure – both from the US and from inflation!

Recall that China’s economy has been at the forefront of the global economy, posting stellar growth quarter after quarter after quarter. Along with this growth was a strong case of domestic inflation, wherein the markets were flooded with business investments, particularly in the building and housing sector. Sure, inflation isn’t really bad, but when prices are rising almost 4% per month, worries start to arise.

In order to combat inflation, the PBOC announced to the world last weekend that they will be moving to a more flexible exchange rate. This new policy will let the Yuan appreciate (and depreciate) more freely versus a set basket of currencies. Hopefully, this would increase the purchasing power of the Yuan and deter inflation.

What does the PBOC’s move mean for their economy? For one thing, a more flexible exchange rate policy could help prevent China’s economy from overheating. As I mentioned in my recent entry, China’s trade balance and inflation figures seem to be rising uncontrollably. Yuan appreciation could keep these in check by allowing China’s exports and production to cool down.

Aside from that, a stronger Yuan translates to higher purchasing power for Chinese firms. This means that they’d be able to purchase more goods and raw materials from commodity-rich nations – definitely good news for its major trade partners! They’d have to step up production and hiring in order for their exports to keep up with increasing demand for the world’s third largest economy. No wonder the Aussie and Kiwi jumped for joy and reached new monthly highs right after the PBOC’s announcement.

Looking at the bigger picture, it might still take a long while before global trade rebalancing is achieved. After all, the PBOC emphasized that any appreciation of the Yuan would happen gradually. For now, it might be best to wait and see how the rest of the economies react to China’s latest move, especially now that the G20 meeting is coming up…