Date 16 June 2010
China’s currency peg has always been a thorn in US-China relations. The yuan peg to the dollar was adopted two years ago, in a bid to shield its exporters from the fallout of the global financial crisis. Whether the Chinese yuan was truly undervalued and its impact on the US trade deficit is a subject for academic debate. On June 19th, the People’s Bank of China (PBOC), the country’s central bank, said it would increase the “flexibility” of China’s currency, ending months of speculation by financial pundits around the world.
However, the PBOC made it clear in the announcement that there would not be a “large-scale appreciation” of the exchange rate. It is likely that the central bank will first allow the yuan to wobble by up to 0.5% each day. Fears that the euro-zone crisis might affect its economic momentum and worries that a sharp appreciation would hurt Chinese exporters should mean a more cautious approach.
The PBOC also said it will be guided by a “basket” of currencies, not the dollar alone. If the euro resumes its slide in the next few weeks or months, the yuan might even be nudged down a bit against the dollar, to keep its trade-weighted value stable.
It is best to see PBOC’s move as a slow, deliberate step towards a more sophisticated currency regime, rather than a stronger currency per se. As China’s economy evolves over the next few years, weaning itself off investment spending and towards consumption, it now has a suppler exchange rate that can help guide and cushion that process.
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