China Fund - Yuan

	Yuan Revaluation
	The People’s Bank of China (PBOC) and the government advisers to Chinese President Hu Jintao (President Hu) have abandoned the yuan’s decade-old peg to the dollar. PBOC will shift to a managed floating exchange rate regime based on a basket of currencies. The exact composition of these currencies is as yet unknown. As part of the shift, the yuan will be allowed to appreciate about 2% to 8.11 yuan/dollar versus 8.28 yuan/dollar. “In general, this is something that the markets were looking for” said Todd Clark, head of listed trading at Wells Fargo Securities. “The cost of some of the goods that we import from China is going to increase a little bit, so short-term, it would be a negative for some of the products.” China’s politically sensitive trade deficit with the U.S. could easily top $200 billion by yearend, vs. about $160 billion last year. Its global trade surplus could jump 400% from $30 billion to more than $120 billion in 2005. This is an important first step in the gradual liberalization of China’s fixed currency regime and an eventual capital flow liberalization. U.S. Treasury Secretary John W. Snow welcomed the move, calling it “good news for China and good news for global economy”. PBOC set up a basket of currencies that include the dollar, euro, yen, and possibly a broader set that include the money of China’s dozen or so top trading partners. Those currencies will now fluctuate in value against the yuan, but as one appreciate, others might fall, balancing out the overall effect on Chinese trade. Since this is a “manage float”, Chinese authorities will probably keep exchange values-especially the dollar/yuan rate-from experiencing really big shifts in either direction. Such a scheme would not change the makeup of China’s $700 billion in foreign currency reserves, nearly three quarters of which are in dollar assets such as U.S. Treasuries. Beijing will no doubt still need the US Dollar, the world’s most liquid currency, so it’s unlikely that China would orchestrate a destabilizing sell of its U.S. treasury holdings that would harm its biggest export market. Was this move merely symbolic? Why did China bother? It can still keep the yuan in a tight range against the dollar while giving the illusion of a market-based system. Although China’s top trade partner is the U.S., it exports almost everywhere. A basket should ensure steadier prices for customers worldwide, not just Americans. Another plus for China is that it may not have to disclose the basket’s composition, which means it could still play with the exchange rate by changing the mix, giving dollars more or less weight. A currency basket and a more flexible yuan should have another payoff: it will ease the flood of speculative cash into Chinese money markets and real estate that has been a difficulty for monetary authorities. Many speculators have been betting that China would have to let the yuan rise. For instance, outstanding foreign-denominated debt (mostly dollars) borrowed in China grew 18%, to $228 billion, in 2004 year-over-year. Nobody expects dramatic appreciation of the yuan right away, and investors will continue to be long on China for a variety of good reasons.Once the PBOC’s new system gains credibility and the yuan has greater freedom to rise and fall more quickly, speculators can no longer assume that time is on their side. More important, a more flexible yuan should help China smooth out the boom and the bust cycles that can be devastating to an emerging economy. If China follows through, the shift will be remembered as an important turning point in the developments of its financial markets and economic maturity. Meanwhile the money pouring into China funds has not slowed down since investors feel this could be the beginning of a new investment impetus to own China assets.

For advertising or partnership opportunities please email us.