The imminent yuan float meme

The kind of attention the Chinese yuan gets is fascinating.  At the height of the debt ceiling nonsense and the subsequent days, the yuan surged to a record high against the $US, and made some of the largest moves on record.  Countless reports told stories that it signaled Beijing’s ambitions for internationalisation, or the use of the exchange rate as a monetary policy tool, or Beijing’s increasing dislike of the $US. Whatever.  Of course, in the subsequent days and weeks, the yuan has not been doing much against the $US, and the stories have faded.

Let’s get this straight: first off, if something is allegedly “undervalued” and has been rising from the “lows”, that thing is bound to make record high after record high. Second, we all know that Chinese policy makers make things happen at a pace that they think is appropriate, so you never know where we’ll end up.  Think of the so-called “through-train” arrangement for Hong Kong shares in 2007: it was so hyped that boosted that Hong Kong stocks flew to the heaven, only to fall back to hell as it turned out to be a mere blank cheque.

The latest Bloomberg report which suggests that Yuan will be convertible by 2015 is yet another example of the sort of thing that has to be taken with caution.  First of all, there are still 4 years in between.  Second, nobody knows what policy makers will be thinking about even tomorrow, let alone 2015 (and we will have new Chinese leaders as well).

The problem here is that even though the growth of the Chinese economy is now probably relying less on exports, it’s still a big chunk of the Chinese economy, and the export sector is now struggling, thus it’s hard to see why Chinese policy makers would be happy to allow a Chinese yuan float (if that means the yuan will appreciate substantially, which is not entirely certain).  And for the yuan to be fully convertible, it will require policy makers to take away capital controls.

Take a step back and consider the Chinese economy today.  It relied on foreign demand for its exports, and foreign capital for its investment. As a result, the Chinese economy has been running a chronic current account surplus as well as capital account surplus (do note that the capital controls in China mean the capital can go into the country more easily than getting out), and the soft currency peg, if you like, forces China to print money and accumulate foreign exchange reserve, helping China to produce all sorts of liquidity.  That’s how the country funds its investment-led growth.

Whether and when the yuan will float depends on whether the government judges it to be good for the Chinese economy (whatever it means).  For one thing, floating its currency and making it fully convertible removes the need to create so much money and accumulate foreign exchange reserves. But that money creation is what it needs to fuel the investment-led growth model, and floating the currency will most probably put an abrupt end to that.

Don’t get me wrong.  I am not saying that the yuan will never be fully convertible.  I am also not saying that the yuan has no chance to be a new reserve currency.  No one knows how things are exactly going to unfold.  You can say what you like, but I wouldn’t believe any so-called “commitment”.

And by the way, the PBOC governor Zhou Xiaochuan just denied there is any defined schedule for convertibility.


  1. Very good article which highlights the difficulties of knowing what the Chinese authorities are planning (and why!) and the patient way that they approach issues.

  2. If the Chinese monetary authorities were looking after the banks alone, they may float the yuan and deregulate the Chinese banking system. As a result, the country would spend more than it earned and run up foreign debt. Also, local industries would be undermined and China would have higher levels of unemployment.

    However, the Chinese monetary authorities are not looking after the banks alone. They are acting in the interest of the whole economy.

    They know the effect that the floating exchange rate system has had on the USA and Europe (as well as Australia). The banks in those countries have prospered for a while but many of their other industries have collapse.

    What possible reason would the Chinese Authorities have to float the yuan?

    While we may have low expectations of our own monetary authorities, we cannot expect all monetary authorities to act only in the interest of their banking industry.

    • What possible reason would the Chinese Authorities have to float the yuan?
      The reasons are outlined when they call for a second global reserve currency.
      I guess a fair summation is : USD=Poo

      • Reserve currencies are relevant only to countries with fixed exchange rates.

        There is no need for a reserve currency for countries that float.

        Therefore, if China wishes to be a reserve currency, it should continue to fix its exchange rate.

        However, I doubt that China would wish to be put in the position that it is in any way responsible for the currencies of the rest of the world.

        • The last 2 sentences draw an interesting dilemma.
          If China wishes to be a reserve currency, it should continue to fix its exchange rate.

          However, I doubt that China would wish to be put in the position that it is in any way responsible for the currencies of the rest of the world.
          So the answer is??? What do the Chinese envisage?
          The Euro?? Very amusing

    • The problem with the yuan-US dollar peg is inflations that is caused by the US printing press.

      I believe what the Chinese authority means by ‘full conversion’ will be a peg which uses a ‘basket of currency’ where Chinese business can export in USD while import in Euro. It will not work due to arbitrage, but China will try it out regardless.

  3. Witchsmeller Pursuivant

    How much did they expand their money supply by in 2008/9? 16% was it? I’m beginning to suspect the belief that the Chinese are “patient” and “plan long term” is nothing but Orientalist nonsense.

      • Witchsmeller Pursuivant

        We also did not have food riots throughout our country Leigh. Or do we not think that inflation exists?

        • I doubt that there were food riots throughout China. High food prices would represent a transfer of income from the cities to the country side.

          The farmers would be celebrating as the wealth of China started filtering down to them.

          There is a difference between the effect of increased money supply on inflation in China and Australia. In Australia, much of the new money we create has to go to service domestic and foreign debt. That reduces the demand for food and other products. Hence it does not cause the same inflation as in China which does not have the same debt problem.

          • Witchsmeller Pursuivant

            I have friends in China, fairly well off, but they inform me reliably that inflation is rampant. By their account vastly higher than what is reported. But this is no secret, unless one wishes to live under rocks.

          • I am not denying that there is inflation in China.

            I suggested that if food prices were rising, that may represent an income transfer from the city to the country.

            In 2009, economic growth in China was around 9% and in Australia around 2%. Therefore the 16% increase in the money supply in China was not a serious problem. Inflation actually fell from 5.9% in 2008 to -0.7% in 2009.

            Inflation has increased again in China since then but we need to keep things in proportion. A 16% increase in the money supply for a country with economic growth of more than 9% is not likely to cause an inflationary disaster.

            An increase in the money supply of 14% for a country growing at 2% is of greater concern.

          • Part of our increased money supply ends up in imports. Thus creating more Foreign debt.
            Perversely, as a result of declining prices from China this has also resulted in low inflation.
            If you look at the ABS figures we have domestic inflation of 5 to 6%. Declining import prices offset the domestic inflation to bring it down to less than 3%. (Well as it is measured)

            As an importer and long-term frequent visitor to China I can assure you this situation is quickly reversing and the piper will have to be paid.

            That aside, Zarathrusta’s and Leigh’s conclusions here re floating etc are pretty spot on as far as I can see.

        • That set off a flurry of emails! My correspondents are mainly in small cities at prefectural (for want of a better word) level or lower. No reports of riots but some inflation of food prices possibly balanced by more spending by producers and packers. One, in a moderately large city (above 10 million population), definite food price inflation but housing prices maybe stabilising.

          The usual confused picture I’m afraid. But I’m off there again in a few weeks and happy about that. I’ll learn more but how does an economist teach ‘Colloquial English’?

  4. Having the reserve currency enables the issuing of more, debt and potentially the ability to fund a larger military

  5. On convertibility I think the Chinese are just worried they wont be able to intervene if they float their currency. However currency interventions buying and selling their own currency are done ‘all the time’ so they have little to worry about if they learn how to do that.

  6. An unexpressed assumption is that China wishes the RMB to rival the dollar. That would be very un-Chinese and contrary to their oft-expressed wish for a currency of account (SDRs), in which a convertible yuan plays a significant role. This latter ambition strikes me as more realistic and far less confrontational.

  7. The SDR has a fundamental flaw, in that it should not be able to
    survive Gresham’s Law, being that if a basket of currencies are to
    be used as a settlement for trade, the best will be retained, and the worst will be spent, returning to the original basket as the better currency is withdrawn. This tilts the original”balance” until only the worst remain, and the SDR is no longer worthy as a

  8. There was some discussion above about the increase in China’s monetary supply versus its rate of economic growth, with the argument being that rampant monetary expansion was ok due to “high” rates of growth.

    I wish that more observers realized that nearly all of China’s annual GDP growth is due to investment and construction. The transfer of wealth from city to country, as Leigh Harkness phrased it, has not even begun; persistently low interest rates and subsidies for SOEs mean that Chinese households are forking over literal trillions each year so that the state can keep its superficial, meaningless growth engine ticking.

    Anyone who thinks that the yuan is “undervalued” has also likely not considered how many yuan will flood the market once China has to recapitalize its banks (China’s sovereign debt troubles are vastly understated and are likely far worse than the US’s) to make up for years of bad lending policy. China’s banks had to be bailed out in 2000/1, and the consequences still linger, as income transfers from households to the state has led to declining consumption and rising investment. The 2008 crisis in the West completely blew out China’s near-term opportunities to reorient itself toward consumption, as massive investment took up the mantle of maintaining high growth (even so, real GDP growth in early 2009 was negative, despite gov’t figures!)

    The degree to which China micromanages its banks and currency means that, for now, there is no clear route for the RMB to become a reserve currency…and I don’t know why China would want it to do so, since the US’s experience as the printer of the predominant reserve currency only means that it gives foreigners too much leverage in running trade surpluses against the US (see the Pettis FP article linked to above by China Fanboy).