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.

[RightOnTheLeftCoast]

"The Democratic Party is celebrating. Promoting devaluing the dollar helps their constituency and hurts the savers of this country; Republicans. Union factory workers benefit marginally at the cost of all U.S. consumers having to pay higher for imported goods. Republicans whose savings are in the U.S. dollar, have just lost world purchasing power. It drives me crazy that a Republican administration is promoting devaluation of our national currency and that many conservatives on this forum are cheering this news."

Let me count the ways you are wrong. What is being addressed by the Bush Administration--and brilliantly I might add--is a two-decade-long trend towards a "service economy" for the U.S. The result was a flight of manufacturing from these shores which had its most obvious culmination in the Nafta Shaft-a. At the root of all this is a currency which was allowed to "strengthen" (what a silly depiction) versus our economic competitors, especially Europe. Now it's China's turn.

Welcome to the new export economy, coming to a job mart near you.

[oceanview]

alot of those other Asian countries get the money to buy chinese goods - by selling stuff to the US. So when we buy something from Malaysia, the money we send there helps them buy chinese products.

the bottom line - if the US consumer sneezes, everybody else catches pneumonia. Asia has built up too much excess capacity, all of it targeted to exports.

[Getsmart64]

they can't take us down without destroying themselves. the US has all their customers.

Not true....not sure about the rest of Europe but in Italy...in their discount stores..i.e. Walmart type stores ...the majority of goods has the Made in China stamp...

[Getsmart64]

It drives me crazy that a Republican administration is promoting devaluation of our national currency and that many conservatives on this forum are cheering this news.

China's economy is booming..I mean BOOMING...no where to go but down...just ask the Japenese....

[Getsmart64]

The biggest promoters of devaluing the dollar has been the Democrats. History has never shown an instance where devaluing a countries currency has made them stronger. The reverse has always been true.

Could you please enlighten me on this subject...Clinton killed the dollar against the yen..(no Clinton fan here puhleese).....when I arrived on station in Japan in '91...it was 145 yen to the dollar....under Clinton...by '95...it had dropped to 65 yen to the dollar....so what happened to the Japanese economy?

[Getsmart64]

Chinese leaders, unaccustomed to capitalism, frequently asked Washington why the value of the dollar kept changing. Officials in Washington answered, "Fluctuations". Chinese leaders responded, "Oh, yeah? Well fluc you white guys! No more link to dollah."

HAHAHHA....funny dood....

[null and void]

*groan*

[Hillarys Gate Cult]

True. This is a only a short term solution. It will blow up in their face. If there was no downside, nobody would link their currency to the dollar. Now they're at the mercy of other currencies in the market. High fluctuations up and down are now their financial fate.

Seems to me they're trying to smokescreen their banks irresponsible lending practices which will cause a collapse.

[headsonpikes]

Shoulda bot those long bond puts yesterday!

[PeterFinn]

They still aren't floating the Yuan on the international market. It's a budge, but it isn't what needs to happen.

[oceanview]

yes, China is booming because of the peg. The peg has allowed them to create what is essentially a phony enterprise zone - into which they are sucking western investment capital. the plants being built in china, aren't being built in the western economies - and the jobs are going with that investment, leaving the West with job growth in services, health care, government, education, etc.

[oceanview]

its got to start somewhere.

[backslacker]

1 Billion Chinamen making less than $1000 a year is not a huge market.,

Do you have a source for your numbers? These numbers below are from the C.I.A.'s website ( http://www.cia.gov /cia/publications/factbook/print/ch.html

GDP: purchasing power parity - $7.262 trillion (2004 est.)
GDP - per capita: purchasing power parity - $5,600 (2004 est.)

Yup, that's right: China's economy is about sixty-two percent of the USA's!

Unocal shareholders: Vote YES to Chevron's bid, NO to China's takover bid.

[Southack]

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

No. It means that to maintain their new exchange rate, that they now have to buy fewer U.S. Treasuries. So China is still buying, just not as many.

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

Interest rates will rise some because China and other Asian nations are now going to be buying less U.S. debt (of course, the U.S. is also running up less debt than anticipated; that factors in, too).

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

Housing is a beast almost unto itself. Tehran, Iran has much higher housing than does the U.S., even though Iran has a crappy economy. Population growth, however, can drive up housing all by itself in many cases...sometimes even causing shifts in social behavior (e.g. two families sharing a house instead of owning one house per family).

Ditto for Moscow, Russia.

You can bring a trailer home into the deserts of booming economies in Nevada and Arizona and get cheaper housing than what people in depressed economic areas pay. So housing doesn't always track economics. Lots of factors in play there.

[Southack]

"Yup, that's right: China's economy is about sixty-two percent of the USA's!"

No, that's the bureaucrats at the CIA claiming that Chinese can live at 62% of our standard of living. Note their term "purchasing power parity" rather than actual Dollars.

[groanup]

Heard there was a huge seller of puts at today's lows and a huge buyer adding to a big call position. If yields keep spiking these guys will only add to the misery with their unwinds.

[connectthedots]

i don't think you quite comprehend just how much product Walmart moves and how big of a short run to medium run impact they can have on the business of their suppliers. If you think there are not other companies willing to step in and replace their current suppliers, you are kidding yourself.

Keep in mind that a general increase in prices does not apply to all customers across the board. Walmat wields a very big hammer.

[RightWhale]

It's a big step. Changing the money basis usually is.

[satchmodog9]

looooonnnggg way off.

I love Chinese food.

[A CA Guy]

There were reports in the news that China was supplying terrorist with weapons and maybe they know there will be hits and don't want to be in American currency when that happens.

IMO, regarding China, what goes around will come back around and destroy them.