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CHINA'S SUBTLE SHIFT IN ITS EXCHANGE-RATE POLICY could help correct global imbalances but the stock market won't benefit.
Just ahead of President Obama's trip to Asia next week, the People's Bank of China implicitly acknowledged the need for a strengthening in the remnimbi, which has been de facto pegged to the dollar since the summer of 2008, just before the Beijing Olympics.
With an interruption for the dollar's rebound during the worst part of the financial crisis in late 2008 and into early 2009, the greenback has been in a steady decline. That also has meant the remnimbi has been falling in tandem against other major currencies, from the euro and the yen, to increasingly important currencies of trading partners, such as the Australian dollar and the Brazilian real.
The impact of this decline has been two-fold. For China, the de facto drop in the remnimbi has complemented its aggressive monetary and fiscal stimulus programs enacted in the wake of the global financial meltdown late last year. The lower RMB helps to support China's export competitiveness while other nations' currencies rise.
For the rest of the world and the U.S. in particular, China's currency peg has pumped and recirculated liquidity to the rest of the globe. In order to maintain a stable RMB/USD exchange rate, China's central bank has to buy up the billions of extra dollars that the nation's exporters earn; if it didn't, the surfeit of dollars would push the RMB higher.
Those dollars get redeployed mainly in the U.S. Treasury market, financing Washington's fiscal deficit and the nation's current-account gap. America thus gains cheap capital for its domestic economy and to cover its external gap.
In announcing its change in stance, China's central bank said it will take into account capital-flow changes and fluctuations in the values of major currencies in managing the RMB.
In other words, the PBC won't rigidly hold its currency's exchange against the ever-sinking dollar. That could mark a return to steady but gradual increases in the RMB's exchange rate, as was the case for in 2005-08.
Timing the shift in exchange-rate policy to coincide with Obama's trip to Asia clearly scores diplomatic points for China. But make no mistake, Beijing does what is in its interest, first and foremost. Chinese authorities would accede to a rise in its currency only if they saw an economic benefit.
With its economy having barely felt the effects of the Great Recession, because of its adept application of massive stimulus, the risk to China's economy now is overheating and inflation. Chinese monetary authorities earlier this week moved to tighten policy because of those dangers. A higher RMB would help dampen commodity inflation and help keep down the prices of other imports, such as capital goods from Europe, thus complementing any domestic tightening move.
Stability is the paramount aim of Chinese authorities; stability in the economy, stability in policies, and stability in its society. To absorb the millions of rural peasants seeking to escape poverty in the manufacturing centers, it is imperative to maintain. That means avoiding unsustainable booms that inevitably lead to busts.
Ironically, the rigidly fixed RMB exchange rate could have been contributing to instability. The global gusher of liquidity is floating the prices of all risk assets, from equities to credit markets to commodities. Indeed, every quasi-fixed exchange-rate regime from Bretton Woods on down has wound up generating worse imbalances. Neither the true discipline of a fixed, gold-based system was imposed, nor was the scope of adjustment under truly freely floating exchange rates permitted.
China, as noted, is focused on its own situation, so it is unlikely that any policy changes are motivated by the desire to cool speculatively driven global markets.
But by permitting the RMB to adjust, it reduces the pressure of adjustment of imbalances from of other currencies. Indeed, by working to reduce the most grotesque imbalance -- the U.S.-China bi-lateral trade gap -- exchange-rate adjustments could stave off the greatest danger lurking for the world economy.
Political pressures for trade curbs are certain to rise with the U.S. unemployment now in double digits and likely to head higher going into the midterm elections of 2010. Whatever China can do on the currency front would weaken the protectionist case.
But it would also turn down the fire house of liquidity that's floating global markets. Which mightn't be such a bad thing.
Comments: randall.forsyth@barrons.com
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