Looser Chinese Currency Controls

The announcement of looser Chinese currency controls has been met with mixed reviews. The US government, the Europeans, and many others, would be pleased to see a much stronger Yuan. The thinking goes that a stronger Chinese currency makes it easier to profitably export to China. At a time when the USA is slowly emerging from the recession and Europe is back in the red for a year, anything that creates jobs will be welcome. To a degree looser Chinese currency controls are a surprise as China has studiously kept its currency on the weak side by purchasing foreign currencies, especially the dollar, with its impressive export profits. This is the game plan followed for years by Japan, Taiwan, and others. Keep you currency weak so that you products are cheap and attractive in the two large and rich markets of the world, North America and Europe. The problem for China is that the other nations of the world are dealing with more or less battered economies across the board and have ceased to be amused by the monetary policy of the world’s fastest growing export economy. However, barring an early Euro Zone debt resolution, China will, itself, see slower growth in the coming years.

How Is This Going to Work?

First of all, what Chinese authorities did was allow the Yuan to float one percent up or down in the Yuan – USD exchange rate during a trading day. The limit was half a percent. This float is up or down from a benchmark rate that the Central Bank of China sets every day. Although the Yuan is able to float throughout a larger range, the range is effectively set by daily Chinese monetary policy. If you wish to trade a declining Yuan based on reduced exports or a rising Yuan based on global recovery, remember that the range is still set by Chinese monetary policy and not the market. This can be a problem for long term traders. However, the new policy of looser Chinese currency controls provides traders with a wider range in which to trade and, hopefully, a little better chance of making profits.

What Are the Issues Regarding Looser Chinese Currency Controls?

The Yuan has appreciated by more than four percent a year for the last half decade. The Chinese government has been under increasing pressure from North America, Europe, and elsewhere to let it currency float, without restraints. The belief of many, outside of China, is that a free floating Yuan will become much more expensive making Chinese goods more expensive and goods from North America and Europe more competitive. However, China recently had its first trade deficit in more than a decade. There is the prospect of a Chinese real estate crash and less demand for Chinese goods due to recession in Europe. Thus it is not absolutely clear whether looser Chinese currency controls will result in a free floating Yuan that will simply continue to go up or if it may even level off or go down. As China loosens its currency controls it may be easier to see which direction the market really wants to take the Yuan. In the long run China would like to see the Yuan become one of the world’s reserve currencies. To get there they need to bite the bullet, engage more thoroughly with other trading nations, and let the Yuan find its own level.