China Tells

Back in mid June, PBOC announced to de-peg RMB from USD. Since then, RMB did appreciate about 1% by early August but then reverted back near to the prior de-peg level. In summary in the last 2 months, RMB has almost not moved at all against USD.

Does it mean that the so called de-peg is a fake from PBOC? Or is PBOC waiting for a better time to take more aggressive action? My view is that we are likely to see RMB to make bolder move against USD in the next few months.

I have a few observations to support my opinion.

First, Chinese government is sending messages to the public in support of a more flexible exchange rate regime. This message is well reflected from a series of public announcements made by the Deputy Governor of PBOC, Ms Hu Xiaolian. Ms Hu has published five speeches recently to convey the message that Chinese authority has always supported a managed floating exchange rate regime, dated back to 1994. According to Ms Hu, the range of the floating adjustment shall be based on trade and current balance and a flexible exchange rate helps to improve the independence of monetary policy, and curb the imported inflation.

Ms Hu’s public speech shall be perceived as a warming up for Chinese government leaders to implement more aggressive policy changes in the near future.

Second, US want China to appreciate the currency faster.

Since the beginning of May, US economy starts to show more negative outlook, which leads the market to suspect a potential double dip. The unemployment rate in the US is still hovering at a very high level of about 10%, and the Obama government is running out of time to show the voters that they have the capability to lead the nation out of recession. In addition, it seems that the trade fundamentals between US and China are heading back to the imbalance status, in which China continues to accumulate more trade surplus while US continues to post record trade deficit. In July, China registered a whopping growth of 43.9% in export growth and also reported a trade surplus of 20 billion USD, which is the highest since the beginning of the year. Such is a worrying signal that the global imbalance that might be one of the reasons to contribute to the financial crisis is recurring again.

Thirdly, neither US nor China wants to see an outbreak of trade war between the two. With the mounting political pressure to build up in US before the mid term election in November, there is more likelihood for US to resort to trade protectionism if the trade imbalance between the two nations continues. On the other hand, the trade protectionism shall be the last choice for Obama administration as it would be detrimental for a weak US economy, and against US governments’ stance to promote free trade. Trade war would also cause detrimental effect on China’s export sector and the whole economy, which is more damaging than an appreciation of RMB.

To summarize above, I think we are more likely to see an appreciation of RMB rate than a trade war to occur between China and US.

As to the timing, I think we are likely to see the rate to be changed more aggressively by November. The reason is that there are a few important events to take place in November, such as the G20 summit in Seoul, the US mid-term election and the Strategic dialogue between China and US to take place in Washington DC. Based on past experience, such period could be a good opportunity window for Chinese government to implement more aggressive policy change on the rate of RMB.