China Severs Its Currency's Link to Dollar

AP ^ | 7/21/05 | STEPHANIE HOO

[Boiler Plate]

BEIJING - China dropped its politically volatile policy of linking its currency to the U.S. dollar on Thursday, adopting a more flexible system based on a basket of foreign currencies that could push up the price of Chinese exports to the United States and Europe.

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The government also strengthened the state-set exchange rate to 8.11 yuan to the dollar — from 8.277 yuan, where it had been fixed for more than a decade — in a surprise announcement on state television's evening news. That raised the value of one yuan by about one-quarter of one U.S. cent to 12.33 cents.

China had been under pressure for years from its trading partners to let the value of the yuan float or at least trade at a stronger rate and some U.S. lawmakers had threatened to impose retaliatory tariffs if China didn't adjust its currency scheme. The United States and others had said the communist nation undervalued the yuan by up to 40 percent, giving Chinese exporters an unfair price advantage.

The Bush administration on Thursday praised China's decision but said it planned to monitor the country's implementation of the new arrangement.

"I welcome China's announcement today that it is adopting a more flexible exchange rate regime," Treasury Secretary John Snow said in a statement. "As we have said, reform of China's currency regime is important for China and the international financial system."

The White House also hailed the announcement. "We are encouraged by China's announcement today that they are adopting a more flexible market-based currency system," Bush spokesman Scott McClellan said.

The new system puts tight daily limits on changes in the yuan's value but could allow it to change substantially over time.

Beginning Friday, the yuan will be limited to moving each day within a 0.3 percent band against a collection of foreign currencies, the government said. But the officially announced price at the end of each day will become the midpoint of trading for the next day, which could let the yuan edge up incrementally.

"This is the start of a gradual appreciation process," said Frank Gong, managing director of JPMorgan Chase & Co. in Hong Kong. "It will help balance Chinese trade flows. Export volumes will come down. Import volumes will pick up. It will help reduce trade tensions."

The move could nonetheless help Chinese exporters' profits by cutting costs for imported oil, iron ore and other raw materials whose prices have been surging in dollar terms, Gong said.

And it could encourage domestic spending, making China's economic growth less dependent on exports, Gong said.

"China is finally doing the right thing," he said.

The U.S. dollar dropped against the Japanese yen — an Asian benchmark — on the news, falling to 110 yen from about 112 yen. U.S. treasuries fell alongside the dollar as investors feared the possible inflationary effect of higher import prices in the U.S. The yield on the 10-year Treasury note rose to 4.22 percent from 4.18 percent late Wednesday.

Japan, one of China's trade partners that had urged it to let the yuan float, welcomed China's decision.

"We hope that this decision will lead to more balanced and stable economic growth for China," the Bank of Japan's international department said in a statement. "We highly value this move."

In South Korea, government officials said they didn't expect it to have a big impact on the nation's economy, the third largest in Asia following Japan and China.

"Yuan's revaluation was only a matter of timing; we knew it was going to happen," said Rhee Yeung-kyun, assistant governor of Bank of Korea. "I don't expect much effect the Korean won as the won has been sufficiently been appreciated."

Philippine central bank Gov. Amando Tetangco said the move was expected to strengthen regional currencies, including the Philippine peso.

The governor of the Bank of Thailand held an urgent meeting with other senior central bank officials as soon as they learned of the news, but no details of their meeting were immediately available.

Yuji Kameoka, currency analyst at Daiwa Institute of Research in Tokyo, said China's decision made sense.

"It was good timing because the dollar has been strengthening lately," he said. "It would have been very difficult to do if the dollar had stayed weak."

Malaysia simultaneously announced it was dropping its own policy that tied its currency, the ringgit, to the U.S. dollar and would adopt a currency basket arrangement similar to China's.

There was no word on whether the value of the Hong Kong dollar would change. Hong Kong is a key Chinese banking center but has its own currency, which also is pegged to the U.S. dollar.

Chinese leaders have said for years that they eventually would let the yuan trade freely on world markets. But they said any decision would be based on China's economic needs, not foreign pressure.

Chinese officials said any abrupt change in its currency system would cause turmoil, hurting its fragile banks and financial industries.

The central bank's news department said there no plans for a news conference to clarify the new policy.

[ninenot]

Blink is right

TWO friggin' percent--

The smallest guess I've seen was that the yuan was undervalued by 25%, not TWO percent.

[connectthedots]

Wal-Mart is a very shrewd negotiator. They have been the indirect cause of putting several companies into bankruptcy because those companies start doing business with Wal-mart and Walmart is a very demanding customer. In may instances, companies sell to Wal-Mart at below their average costs, but a bit more than the marginal costs for a certain volume.

Wal-mart comes back an demands more product at the same low prices. There comes a point when the supplier is not only selling at below average costs, but below the average marginal costs.

At some point, it catches up and companies get sucked into it at a point where they think they can no longer turn away Walmart business. Wal-Mart is very good at threatening to tale away all the business if you do not supply as much as they want at the low price they demand.

There have been a few companies who understand how this works and have simply told Wal-Mart the terms under which they will sell to Wal-Mart. Those companies understand that no business is much better than bad business.

Wal-Mart is doing the same thing to China.

[swarthyguy]

There's a bad joke here about Juan and the Yuan......

[snowsislander]

"It will help balance Chinese trade flows. Export volumes will come down. Import volumes will pick up. It will help reduce trade tensions."

I don't believe that from what I have seen of the yen / dollar exchange rate fluctuations that there is any real correspondence between a stronger yen and a lower volume of imports by the U.S. of Japanese goods.

I will be surprised if a 2% change in the yuan would be any more likely to have any lessening effect on our rapidly growing import of Chinese goods.

[ex 98C MI Dude]

This means the Chinese will buy fewer US T-Bonds, meaning we will have to find someone else to prop up the dollar. In March and April the Federal Reserve landed up buying up T-Bonds that weren't sold at the bond auction. That has never happened before. The Fed had to create US debt to buy the US debt that was up for sale. The dollar is in trouble, but there are no viable fiat currencies to take its place as the reserve currency.

Life is going to get economically interesting in a couple years...

[headsonpikes]

Comments from Dennis Gartman....

THE CHINESE REVALUATION: OUR QUICK PERSPECTIVE

China has finally announced a revaluation of the Renminbi and no one
should be terribly surprised.

Our first responses to the news:

1. This is a very small change... only 2% and that is far, far too
little to have any major effect upon the imbalance of trade.

2. We are confused as to the "basket" that shall be used, and we wonder
why it is that China is revaluing its currency against the dollar and
then tossing the dollar out, only to replace it with a basket whose
value has not yet been set.

3. This is very bearish of US debt, for even though the change is only
2% this will eliminate a good portion of the intervention efforts the
PBOC has been undertaking to hold the Renminbi steady and thus reduces
demand, at the margin, for that debt.

4. This is modestly bullish of most US equities for it will increase
(slightly) the demand for US produced goods, but this is very bearish
for Wal-Mart and others who buy low end goods from China.

5. This is bullish for commodities generally for they have suddenly has
become 3% cheaper for Chinese buyers, and it is likely especially so for
crude oil.

[connectthedots]

What would lead you to think Wal-mart would actually pay a higher price?

[A. Pole]

China dropped its politically volatile policy of linking its currency to the U.S. dollar on Thursday, adopting a more flexible system based on a basket of foreign currencies that could push up the price of Chinese exports to the United States and Europe.

Bump!

[tyw]

LOL

[Age of Reason]

Does this mean China will stop buying U.S. Treasuries?

And if China stops buying U.S. Treasuries, does that mean long term interest rates will rise?

And if long term rates rise, will the housing market bubble burst?

[r9etb]

The smallest guess I've seen was that the yuan was undervalued by 25%, not TWO percent.

Yeah, but it's the Chinese government who set the exchange rate. It starts off at 2%, but it'll change a lot more than that.

An old rule of thumb is that the "real" exchange rate is the average of whatever you can get from a money changer on the street, and it's usually a lot different from the government-set value. It's been years since I've seen that statistic for the yuan, so I can't say what a real value should be.

[Vision Thing]

Check out post #48.

[Age of Reason]

This means the Chinese will buy fewer US T-Bonds . . . .

In March and April the Federal Reserve landed up buying up T-Bonds that weren't sold at the bond auction. That has never happened before.

The Fed had to create US debt to buy the US debt that was up for sale . . . .

Oh oh.

I have heard that China buying our Treasury bonds was a big reason long term interest rates--and so mortgage rates--have been so low.

If they will stop buying them now this could be it for real estate.

[FlatLandBeer]

Think - what could happen that could devalue the dollar?
Major terriorist attack..or something else...

[ex-snook]

Thanks for ping.

" that could push up the price of Chinese exports to the United States "

I love it when a plan comes together. [A Team]

Ya think they might buy more of our Hollywood pap and gansta rap instead of ripping off our 'intellectual property'.

[Toddsterpatriot]

This means the Chinese will buy fewer US T-Bonds, meaning we will have to find someone else to prop up the dollar. In March and April the Federal Reserve landed up buying up T-Bonds that weren't sold at the bond auction. That has never happened before. The Fed had to create US debt dollars to buy the US debt that was up for sale.

I hadn't heard this. You have a link?