China’s decision to gradually abandon their hard peg to the US$ takes us back to pre July ’08 when it more freely floated. Yes, this comes right before the G20 meeting and with growing international pressure, particularly from the US Congress, but China understands that the move is in their best long term interests in terms of growing the purchasing power of their citizenry, tempering inflation pressures and slowing the incredible trade imbalances that has seen their FX reserves grow to $2.4 Trillion, about 70% of which is in US$s. For China’s growing stature in the world this is great news, although short term difficult for low margin Chinese manufacturers. To those critics in the US of China’s fixed peg, be careful now of what you wished for. The Renminbi has taken a big step to being a global reserve currency and smaller trade imbalances will mean less Chinese purchases of US Treasuries. At last count they own $900b worth.
As evidence that shifting higher the value of one’s currency is not a panacea for its competitors whose currency moves lower, all we need to look at are the Japanese and the yen move from 278 in Nov ’82 to the 90ish level today, a 67% appreciation. At the same time, Toyota became the most successful car company in the world while GM eventually went bankrupt. Bottom line, today’s move is more symbolic than anything because the revaluation of the yuan will be very gradual and not one off but it is a very important step in China’s maturation and global economic relevance.