China’s currency manipulation to soften the slowdown

Perhaps fearful of a steep slowdown in exports to a weakening global economy, the Chinese monetary authorities appear to be engaging in another bout of active manipulation of the Yuan in the foreign exchanges.

Using the pretext of a rise in the cash-to-deposits ratio required by their domestic banks, the Telegraph reports that “banks in China have been required over the last year to hold extra reserves in dollars rather than yuan.”

The result is another sizeable increase in China’s foreign exchange reserves now estimated to be worth £970 billion. China abandoned the fixed exchange rate between the US dollar and the Yuan in July 2005 but progress towards allowing their currency to float freely on world currency exchanges has been very slow indeed. According to Ambrose Evans-Pritchard:

“Beijing’s Politburo is clearly disturbed by the sudden downward turn in the economy as export markets freeze, and surging wage inflation in the country’s manufacturing hubs eats away at profit margins.”

The rest of his article is here

Deliberately keeping the external value of a currency weaker than it might otherwise be if left to market forces is a way of maintaining the competitiveness of exports. Effectively this is a subsidy on exports and domestic import-competing products. And it might encourage other emerging market countries in Asia to do the same. China’s huge trade surplus with the United States ought to bring about a more rapid appreciation of the Yuan against the US dollar.

But currency markets rarely move purely because of imbalances in trade between nations. The Chinese monetary authorities look to be between a rock and a hard place. On the one hand they need to control excessive monetary growth and inflationary risks. On the other they fear a loss of competitiveness caused by a rising currency and the emergence of other centres of low-cost manufacturing in countries such as Vietnam and Bangladesh. Growth could well slow down to below 9% in 2009 which may come as something of a shock for a nation that has become accustomed to expanding at double-digit annual rates for several years.

Games no help to Chinese shares (BBC news, August 2008)