China Plans To Drop Dollar Peg to Slow Inflation

The Globe And Mail reports that China sets plan to let currency move higher.

China sets plan to let currency move higher
Andy Hoffman and Barrie McKenna

China signalled it will allow its currency to appreciate against the U.S. dollar, bowing to international pressure days ahead of a visit from U.S. President Barack Obama.

The move to allow the yuan to rise against the greenback would provide much-needed relief to countries trying to compete against China's mighty export machine and put further downward pressure on an already battered U.S. dollar.

China's latest quarterly monetary policy report said its foreign exchange policy will now consider "capital flows and changes in major currencies," indicating China will carefully expose the yuan's value to fluctuations in global markets.

The statement avoided the government's usual boilerplate language of keeping the yuan "basically stable at a reasonable and balanced level."

China's trading partners have complained the government keeps the yuan at artificially low levels, providing an unfair price advantage for China's goods as they compete for market share around the world. Until now, China has largely ignored calls for greater currency flexibility.

The decision to allow the yuan to climb also points to the maturing of China's rapidly expanding economy, while giving its people and companies more purchasing power for goods and assets produced outside the country.

"China is exporting blood and sweat and importing copper and oil. Is that really good in the long term? You are sacrificing the local people's purchasing power in pursuing export growth," said Na Liu, China analyst at Scotia Capital.

The rise in the yuan is expected to be gradual and is not likely to occur until next year. Still, China is likely to quickly draw increased capital flows into the country as international investors aim to benefit from an eventual rise in the currency and local assets. But that trend brings the risk of potential unsustainable bubbles in its real estate and stock markets.

Other Asian exporting countries such as South Korea, Singapore and Thailand, which should be able to compete better with China as the yuan appreciates, are likely to follow suit and let their currencies appreciate as well.

"A little gradual appreciation in the yuan will not naturally hurt China's exports because other Asian countries will follow," Mr. Liu said.

China's currency has been pegged to the U.S. dollar since July of 2008 in an effort to shield exports from the global recession. But the latest economic data released Wednesday suggest a recovery is well under way in China. Industrial production rose 16.1 per cent in October, the most since March of 2008. Exports declined 13.8 per cent, the smallest drop recorded this year.

"It was inevitable," Benjamin Reitzes, an economist at BMO Nesbitt Burns said of China's hint it will shift its foreign exchange policy.

"The reason they can do it now is because they see external demand from the global economy is improving," he added.

Bloomberg reports that China will allow yuan gains to slow inflation.

China Will Allow Yuan Gains to Slow Inflation, Riverfront Says
By Allen Wan

Nov. 11 (Bloomberg) --
China will allow for faster appreciation of the yuan against the dollar next year as it seeks to curb accelerating inflation, according to Riverfront Investment Group and RBC Capital Markets.

"China can either let the yuan appreciate or allow inflation to accelerate at the risk of causing social unrest," said Michael Jones, who manages $1.4 billion in stocks, including Chinese equities, at Richmond, Virginia-based Riverfront. "Inflation pressures will push China to allow substantial yuan appreciation." [this is what I have been predicting]

The world's third-biggest economy expanded 8.9 percent in the past quarter, the fastest pace in a year, according to official data. Money supply increased a record 29.4 percent in October from a year earlier, the central bank said today.

"Rapid Chinese money supply growth led to inflation in 2004 and 2008," Jones said. "It could [will] happen again."

He predicts the inflation rate may rise as high as 7 percent next year, with food prices double that estimate. Under that worst-case scenario, Chinese policymakers may be forced to revalue the currency by 25 percent, Jones said.

Consumer prices fell 0.5 percent last month, the smallest drop since declines began in February, according to a Bloomberg survey. Prices will rise 2.7 percent in 2010, according to the average of 16 economist estimates compiled by Bloomberg.

"Pressure from the international community to allow yuan appreciation is not that big," People's Bank of China Governor Zhou Xiaochuan said Nov. 6.

Economic Stimulus

China's 4 trillion yuan ($586 billion) stimulus spending and record lending may lead to a pick-up in inflation, prompting the government to allow for an appreciation of the yuan, said RBC's global head of emerging research Nick Chamie.

"Strong stimulus and very easy liquidity conditions are likely to stoke inflation pressures in the months ahead, suggesting that tighter policy will be needed -- currency appreciation will likely be part of the package," Chamie wrote in a note to clients.

"We believe that as other currencies continue to rally, China will likely resume a crawling peg strategy against the dollar," Jones said. "Such a shift in policy will likely motivate a rally as global financial markets breathe a collective sigh of relief."

'Material Revaluation'

China may resume the crawling peg as early as next week, when U.S. President Barack Obama visits the Asian country, Jones said.

Asian currencies such as the Taiwanese dollar and South Korean won may appreciate further if the yuan gains as governments in the region have been reluctant to risk further gains on concern they may become less competitive, he said.

"A material revaluation of the yuan could potentially unleash substantial domestic consumption in China, be a catalyst for a boom in global trade, and spark a secular bull market in equities,"
Jones said. ["unleash substantial domestic consumption" would drastically increase the demand for food in the face of a global food shortage]

People's Daily Online asks will China suffer from imported inflation?

Will China suffer from imported inflation?
11:12, November 12, 2009

When the shadow of the financial crisis still lingers on in the world, China's National Bureau of Statistics' recent statement that China will achieve its goal of 8 percent GDP growth for the whole year indicated its earlier recovery than other countries. Experts warned that early recovery may make China the first country to encounter inflation. In Fact, with dollar depreciation and rising commodity prices in the world market, there's now mounting imported inflation pressure on China.
Emerging pressure

Inflation, especially imported inflation, becomes another problem facing China. Countries around the world have injected huge liquidity into their markets.

U.S. monetary base, the stock of money in its banking system, doubled to 1.70 trillion U.S. dollars in August from 842 billion a year earlier. Central banks in Britain and Japan also implemented unprecedented loose monetary policies. In the first ten months, new Renminbi-dominated loans totaled 8.92 trillion yuan (1.31 trillion U.S. dollars) in China. Huge liquidity has generated increasing inflation expectations.

Driven by the depreciated dollar, rising commodity prices in the world market are adding the pressure of imported inflation to China. A report presented in October by Chinese Academy of Social Sciences (CASS) showed that oil prices have increased by 60 percent compared with the beginning of this year, and prices of nonferrous metal and iron ore have grown by around 40 percent. The pressure of imported inflation has increasingly direct influence on China's consumer prices.

The hike of commodity prices was the result of dollar depreciation. As Renminbi exchange rate to dollar remains stable, China will inevitably feel the pressure of imported inflation, explained Zhao Qingming, a senior researcher with China Construction Bank.

Zhao said
China should allow Renminbi to appreciate moderately to reduce the influence of the price hike of imported products.

Bloomberg reports that dollar overwhelms central banks from Brazil to Korea.

Dollar Overwhelms Central Banks From Brazil to Korea
By Oliver Biggadike and Matthew Brown

Nov. 13 (Bloomberg) --
Brazil, South Korea and Russia are losing the battle among developing nations to reduce gains in their currencies and keep exports competitive as the demand for their financial assets, driven by the slumping dollar, is proving more than central banks can handle.

South Korea Deputy Finance Minister Shin Je Yoon said yesterday the country will leave the level of its currency to market forces after adding about $63 billion to its foreign exchange reserves this year to slow the appreciation of the won. Chile Finance Minister Andres Velasco said the same day that lawmakers approved an increase in local debt sales to finance spending, a move that will allow the government to keep more of its dollar-based savings overseas and slow the peso's rally.

Governments are amassing record foreign-exchange reserves as they direct central banks to buy dollars in an attempt to stem the greenback's slide and keep their currencies from appreciating too fast and making their exports too expensive.
Half of the 10-best performers in the currency market this year came from developing markets, gaining at least 14 percent on average, according to data compiled by Bloomberg.

'Slow the Advance'

"It looked for a while like the Bank of Korea was trying to defend 1,200, but it looks like they've given up and are just trying to slow the advance," said Collin Crownover, head of currency management in London at State Street Global Advisors, which has $1.7 trillion under management.

International Investment

An unprecedented net $47 billion flowed into equities in India, Indonesia, the Philippines, South Korea, Taiwan and Thailand in the last three quarters, according to data compiled by Bloomberg. That eclipsed the previous full-year high of $33 billion in 2005, nine year of data show.

"The dollar is weakening because the U.S. has the lowest short-term interest rates in the world will be the sell side of the carry trade as long as that remains true," Chris Low, chief economist at FTN Financial in New York, wrote in a note to clients yesterday.

'Hard to Fight'

Brazil's economy emerged from a recession in the second quarter, swinging to a 1.9 percent expansion after six months of contraction, a Sept. 11 report from the statistics agency showed. Six straight months of job growth, coupled with tax breaks and record low borro wing costs, pushed up consumer spending and helped Latin America's largest economy rebound from the global financial crisis.

"I hear a lot of noise reflecting the government's discomfort with the exchange rate, but it is hard to fight this," said Rodrigo Azevedo, the monetary policy director of Brazil's central bank from 2004 to 2007. "There is very little Brazil can do," said Azevedo, who runs $1.8 billion at JGP SA in Rio de Janeiro, in an Oct. 16 interview. [Brazil could buy more dollars to weaken its currency, but that is evidently not even being considered.]

My reaction: China is signaling that it will drop the dollar peg and appreciate the yuan to contain inflation. So when food prices start rising fast in the next few months, the dollar will start falling just as fast.

Keep in mind that:

Chinese (and world) CPI numbers are about to turn positive

Below is a chart showing China's monthly CPI. As you can see, since February, CPI numbers have been negative, but that is about to change...

The reason CPI turned negative last year was the collapse of commodity prices. Oil and agricultural commodities started trading at lower prices than they did a year yearlier, which drove the cost of food and gas down. However, this November things are about to change.

Below is a chart of oil prices last year. See the price plunged from $90 in October to $60 in November?

Oil prices are now at $80 higher, which is $20 more than a year ago. Higher year on year commodity prices will quickly start showing up as positive CPI numbers around the world and in China.

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2 Responses to China Plans To Drop Dollar Peg to Slow Inflation

  1. Trader says:

    Is it possible that food commodities goes up next year without metal commodities included?

    I see LME copper inventory keep going up lately, now already above 400k ton.

    How could all metal commodities keep going up if there are not enough demand pushing it up?

  2. K. Paul says:

    There's something I don't quite understand. Maybe I'm misreading it. Why does it sound like Obama is *asking* China to appreciate the yuan? Doesn't that mean Obama is *asking* China to dump the dollar peg?

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