Chinese Yuan Off The Peg To US Dollar
China’s shift toward a stronger exchange rate may alter the shape of the world economy’s expansion more than its speed, economists said. The currency move is likely to affect the composition of global gross domestic product rather than the growth rate
Chinese consumers might buy more as the rising yuan boosts their purchasing power, while their counterparts in the U.S. cut back on their spending as the cost of goods imported into America rises. The shift will add 0.1 percentage point to global growth this year and next, leaving the rate at about 4 percent, according to the median of 17 forecasts in a Bloomberg News survey of economists.
China’s central bank said June 19 it will increase flexibility in the yuan, marking an end to the crisis policy of pegging to the dollar.
Export Reliance
People’s Bank of China said the shift would reduce the economy’s “overreliance on exports,” indicating an expectation for the yuan to rise. Some see that the PBOC move was a vote of confidence in the sustainability of the global recovery.
A stronger yuan may make the recovery more durable by reducing its reliance on debt-laden American consumers. While U.S. consumers will pay more as a result of the rise of the yuan, the move is a net plus for the world economy because it lessens the risk of a hard landing in China and a protectionist backlash in the U.S. China has been trying to prevent overheating of its economy after first-quarter economic growth of 11.9 percent.
Cause of Crisis
The longer-term benefit to the world economy may be to make it less susceptible to a cycle of boom and bust by shifting away from its reliance on U.S. spending, which in turn is financed by Asian savings. A U.S. savings rate of 3.6 percent in April is about a 10th of China’s, the highest among major economies.
It was this mixture that helped spark the recent financial crisis and global recession as China recycled the dollars it accumulated from exports into U.S. debt, depressing global yields and fanning housing and credit booms.
A fixed exchange rate is often one of the ingredients of a boom-bust economy, by letting their exchange rate slip upward, most economists expect it to rise 5 to 10 percent a year — the Chinese are protecting their own economy from a bust.”
Risks
However, some economists cautioned that China’s decision might do more harm than good for the global economy. It might be wrong for the U.S. to force China to destabilize the yuan.
Source of Stability
Robert Mundell, a professor at Columbia University in New York and a Nobel Prize-winning economist said that China’s currency peg has been “a great source of stability” for the world economy and called the move to abandon it “political.”
A rise in the yuan could also fan global inflation as other currencies weaken. A more expensive yuan can heat up inflation pressures in the U.S. and elsewhere and that is the last thing the Federal Reserve wants to worry about right now. The Fed, however, is more worried about disinflation than inflation. Excluding food and energy costs, U.S. consumer prices rose 0.9 percent in May from a year earlier, the smallest increase since 1961.
It’s a sign that the Chinese policy makers are more confident about their ability to adjust from a low value-added export economy to one that’s got domestic factors at the core. That’s the most important takeaway.
USDCNY
SGDCNY
Looking at the exchange rate since June 19, USDCNY has depreciated by close to 1%. The SGDCNY graph pre-June 19 actually matches the USDSGD graph. Post June 19, we can see depreciation before the strong Singapore economy boosted SGD to appreciate.
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