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.

[King Prout]

chicom ping

[Boiler Plate]

Officials in Washington answered, "Fluctuations".

Now that's funny!LOL!

[Boiler Plate]

This is much ado about nothing. A significantly undervalued yuan does nothing but hurt China in the long run. china is subsidizing the lifestyle of much of the rest of the world. In the end, it will lead to the implosion of communism in China.

That's knda how I understand it.

[connectthedots]

Where would China put all the stuff they wouldn't be selling to WalMart? Walmart will also tell them to find a way to cut there costs by 2%. Surely anyone can figure out ow to reduce expenses by 2%.

Besides, I am sure Walmart negotiates prices in US dollars well in advance. They are probably telling the Chinese, "We sell in US dollars, so we need to buy in US dollars. The value you place on the yuan is your problem, not ours." Do you think a Chinese manager is going to PO his biggest customer and expect to keep his job?

[carl in alaska]

China will still be running a huge trade surplus with the rest of the world. There will still be massive cash flows into Chinese state-owned companies that they will have to invest somewhere. The only market that's big enough to absorb all that cash without pushing prices to overvalued levels is the US treasury bond market. So they will continue buying large amounts of dollars and treasury bonds.

The recent major decline in our budget deficit will have a much bigger impact on treasury bond prices than this small devaluation by China. As we start to bring troops home from Iraq, probably next year, the budget deficit will decline further and reduce the supply of new treasury debt thus preventing a substantial rise in interest rates. The bigger threat to the housing market is actually rising business confidence and increased capital spending that may boost the technology and machinery sectors in the next couple of years. That could lead to more interest rate increases by the Fed to contain economic growth and rising labor costs.

I think the rejected Unocal bid may have been a factor in this decision--not because this makes Unocal significantly cheaper to buy but because Unocal sent a message to China that Chinese economic policy and business practices are not too popular in the US.

[Kuehn12]

This goes into the category "Your dammed if you do, and dammed if you don't." If China didn't unpeg they would be blamed for the trade deficit in America, and now that they have unpeg people can blame them for a surge in prices of Chinese goods sold in America which might cause some inflation. I think many people have a difficult disconnecting economic policy from geostrategic policy and goals. China needs a health America to sell its goods in, and America needs a prosperous China to buy its goods. Now, it true that both countries want to be top dog in Asia, and China would like to see America less powerful and less involved in their neck of the woods. However,I think in the end both countries would like to avoid a conflict.

I would like to pose some questions to the forum. Why is it after 50 years of ideological conflict and many near misses that we never went to war with the Soviets? Why hasn't there been a truly global conflict since the advent of the Nuclear Age? Finally, What makes a conflict with China any more likely or less likely than it was with a more powerful and threatening Soviet Union?

[carl in alaska]

Chinese companies aren't going to raise prices by 2%, because they have hefty profit margins and they will instead make 2% less profit in terms of Chinese currency. These companies pay very low wages to most workers and make huge profits, so they're just going to eat the 2% devaluation of the yuan. I would expect zero impact in the near term on US inflation from this currency change. In the longer run, continued declines in production costs in these Chinese companies will most likely offset further devaluation of Chinese currency, or these companies will take another minor reduction in profit margins.

[carl in alaska]

By "STEPHANIE HOO"

Hey wasn't she one of the characters in the Dr. Seuss book entitled "The Grinch Who Stole Christmas."? I guesss she grew up to be a journalist...lol.

[durasell]

Didn't their currency rise in value? So it wan't a "devaluation," right?

[carl in alaska]

Yeah you're right, it was a revaluation upward in the Chinese yuan, or a devaluation of the dollar. We've seen so many devaluations of foreign currencies that you get in the habit of thinking "devaluation", but this was an upward revaluation in the Chinese currency.

[durasell]

Thanks...but I think this is worse than you make out. It probably won't have a significant impact on the retail level, but it may impact China's purchase of U.S. Treasuries, etc. I'd note that they are our third largest creditor. In essence, they're loaning us money to buy their stuff, the profits of which are cycled back to loan us more money. I believe the currency revaluation will mark the beginning of the end of this cycle.

[carl in alaska]

See post #65. They still have massive cash inflows to invest. Now it's up to us to reduce our budget deficits. (For a start, how about eliminating pork barrel projects in Sen. Byrd's home state?)

[Always Right]

In other news, the 'Dollar Store' changed its name to the 'Buck 25' Store....

[oceanview]

they will still need to buy plenty of treasuries. Japan has a currency that floats, they buy plenty of Treasuries.

US interest rates are rising anyway. We have been pumping this falsehood onto the american people that debt is wealth. Debt is not wealth.

[durasell]

This is one of those news items that people skip over thinking it has nothing to do with them. And then one day they wake up and a can of soup is $4.50.

[A. Pole]

China blinks. Another victory for the Bush Admin.

Not really.

[groanup]

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.

Treasuries since the yuan action today:

Five year: from 3.98% to 4.09%

Ten year: from 4.18% to 4.28%

Thirty year: from 4.39% to 4.50%

Huge decline in bond prices across the curve.

[A. Pole]

What are the Pros & Cons for China doing this??

The pros is to make Chinese currency more stable (basket of currencies is better than one) and diversification of the currecy reserves. No cons.

[A. Pole]

the US has all their customers.

Not really. In 2002 Chinese exports were:

to Asia 43.4%
to North and Central America 32.1%
to Western Europe 15.6%

US makes less than a third of China customers. So it makes sense to make dollar 33% of the currency basket.