Posts Tagged ‘yuan’


China is being accused of starting a new currency war. The People’s Bank of China has devalued the Chinese currency three times in three days. Politicians on Capitol Hill can barely conceal their ire. There is even talk that both the Fed and Bank of England will hike interest rates as a result. Yet for all that, it may simply be that China is doing what both the IMF and Washington have been calling for it to do for years.

China wants its currency, the yuan, or the renminbi, to be part of the basket of currencies that make-up the IMF’s Special Drawing Rights, or SDR.  For this to happen, the IMF says that the yuan must be allowed to trade freely on the open markets. China say that this is precisely what it is doing.

There was a time when China manipulated its currency, keeping its value artificially low. To achieve this, the government went out and bought western bonds, especially US government bonds. This in turn pushed up on the value of those bonds, causing their yields to fall. It’s an important point that often gets overlooked. Some criticise the Fed’s polices over the years, but truth be told in the long term, it is not central banks which determine interest rates, but movements of money which in turn can be changed by deep forces at play.  China’s policy of maintaining a cheap currency was a major factor in creating low interest rates for much of this century. And while the cheap yuan theoretically led to lower US exports, US borrowing was partly funded by China, and at exceptionally low interest rates.

It is just that the yuan is no longer cheap.  It hasn’t been for some time. If the yuan really was allowed to trade freely, it would surely fall in value. Washington can scream with fury, but China is gradually moving towards a position that the US has wanted it to occupy for years.

After the first devaluation, the IMF said “The new mechanism for determining the central parity of the Renminbi announced by the PBC appears a welcome step as it should allow market forces to have a greater role in determining the exchange rate. The exact impact will depend on how the new mechanism is implemented in practice. Greater exchange rate flexibility is important for China as it strives to give market-forces a decisive role in the economy and is rapidly integrating into global financial markets. We believe that China can, and should, aim to achieve an effectively floating exchange rate system within two to three years. Regarding the ongoing review of the IMF’s SDR basket, the announced change has no direct implications for the criteria used in determining the composition of the basket. Nevertheless, a more market-determined exchange rate would facilitate SDR operations in case the Renminbi were included in the currency basket going forward.”

Some say the timing is cynical, because China has devalued in the same week that saw weak data on industrial production investment and retail sales. That may be right, but so what. China is simply doing what the IMF has recommended, but chosen the most fortuitous moment. What’s wrong with that?

Never forget that before 2008 the Spanish government was held up as a beacon of fiscal responsibility. Of the world’s richest developed economies, its public debt as a percentage of GDP was the lowest. Its banks were held in pretty high esteem too, and when Northern Rock and then RBS and HBOS hit the buffers, the media said we could learn from Spain, and how its banks managed to maintain prudent management of their balance sheet, while at the same time providing mortgages with a very high loan to asset values.

It just goes to show that in hindsight it is easy for people to say: “Of course the problems were obvious all along,” but it is also possible that their backwards vision is a touch rose tinted.

And when others say: “You can’t fix a crisis caused by too much debt by borrowing more,” they miss the point where Spain is concerned.

The real problem for Spain is that during the boom years, the one size fits all approach to monetary policy in the euro area meant that its interest rates were too low, and unencumbered capital flows meant money from Germany and other richer nations flooded into the country.

Actually, if you are experiencing déjà vu, there is a good reason for it. The names were different, and so were some of the circumstances, but the Asian crisis of 1997 was largely caused by similar factors. It was not Malaysia and other so called tiger Asian economies who messed up during the 1990s; it was those who flooded the countries with money. Yet when the bubble burst and the IMF was called in to help, and Alan Greenspan waded into the fray, the priority was to ensure creditors got their money back. They imposed sharp austerity on the countries to which they provided backing. The result was that an economic nightmare was foisted on Malaysia and other countries in the region. A year later, the IMF dealt with the Russian crisis in a similar way. The long term implications of that has been mistrust of the Western economic policies, leading to deterioration in relations between Russia and the West, and the emergence of China’s policy of protecting the yuan.

When the priority is to protect creditors over debtors when the problem was as much down to the errors of the lenders, you end up with a distorted world.

The management at Barcelona might say: “Why don’t you run your football team like we do, and pick all the world’s best footballers, then you too would be unbeatable. “Alas they would be wrong. Some teams must be beatable. And when creditors dictate terms and say: “Be more like us,” we risk creating a world that can only ever know permanent depression.

Before we get to the fix, let’s take a look at Catalonia, and the snag with single currencies.

Also see the following related articles:

Is there hope for the euro? Catalonia’s rift with Spain
Spain’s woes are not down to debt
Catalonia’s strife; currency’s knife
Political shenanigans in Europe
The fix to the euro crisis

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