Yuan disappointment inevitable whether Beijing revalues or not
Just imagine the anticlimax. After all the hype of the last few days - the US Treasury delaying its report on Chinese currency manipulation, the drama of Tim Geithner's sudden flight to Beijing, the chatter from mainland policy advisers about imminent yuan revaluation, the anticipation before Hu Jintao's trip to Washington for the G20 summit - just imagine the crashing disappointment if the mainland authorities turned around and did nothing, made no change to their exchange rate policy and left the yuan pegged at its current level against the US dollar. What a let-down.
Actually, that's an extremely unlikely scenario. If Beijing were really planning to maintain the status quo, then officials would have poured cold water on much of the recent speculation, and the central bank would have taken care to squash yesterday's up-tick in the value of the yuan, which saw the currency climb to its strongest level against the US dollar since May last year (see the first chart below).
But even though a change of policy now looks imminent, don't get too excited. Although Beijing will soon allow the yuan to resume its appreciation against the US currency, it's a racing certainty that absolutely everyone with a stake in the game will be bitterly disappointed with the outcome.
Let's start with the China-bashers in the US Congress, the likes of senators Charles Schumer and Lindsey Graham, who blame the US trade deficit on the undervaluation of the yuan and are threatening punitive tariffs against imports from China unless Beijing allows the currency to rise.
But no matter how high or how fast the yuan climbs, its appreciation won't satisfy Beijing's US critics. We know that from their past record. Back in early 2005, the China-bashers were accusing Beijing of undervaluing the yuan by about 20 to 25 per cent. Over the next four years the currency strengthened by 21 per cent against the dollar and by nearly 27 per cent against a trade-weighted basket of currencies (see the second chart). Still China's critics insisted the yuan was undervalued by about 20 per cent.
Any strengthening that Beijing allows over the next year or so will certainly be modest. Chinese policymakers are concerned about the health of the county's export industries, many of which are already operating on profit margins of 5 per cent or less, and the central bank is anxious not to attract inflationary inflows of hot money. As a result, the offshore forward market is pricing in a yuan appreciation over the next 12 months of just 3 per cent (see the third chart). Some analysts expect more. Michael Buchanan at Goldman Sachs, for example, is forecasting a 5 per cent rise against the dollar by the end of the year.
But even a more rapid appreciation would not silence Beijing's critics. 'Chinese currency cheats stealing honest American jobs' makes for powerfully popular campaign rhetoric. Don't expect a change of tune just because of a small revaluation.
If Beijing's US critics are dissatisfied, Chinese policymakers will be upset too. They believe that by maintaining the yuan's stability and launching last year's stimulus programme, they have more than pulled their weight in ensuring global recovery. Now by revaluing they will be endangering their own fragile export sector and risking destabilising inflows of hot capital, only to suffer yet more accusations that they are doing too little to solve the world's economic imbalances. They are bound to feel hard done by.
International investors will be disappointed too. With any rise in the yuan sure to be gradual, and possibly punctuated by artificial setbacks engineered by the central bank, they are hardly likely to be impressed with the meagre returns to be made speculating on yuan appreciation.
And finally, the political champions of China's export industries will be doubly disappointed by the yuan's rise. Initially they will be aggrieved that their complaints about exporters' thin margins and their warnings about bankruptcies and mass job losses failed to prevent the policy change.
And in the longer term, they will even be denied the bittersweet satisfaction of being proved right. Chinese exporters' margins may be thin, but that's largely because they compete so fiercely with each other, not because they are under pressure from abroad. If the yuan does appreciate the Chinese export industry as a whole will remain highly competitive compared with producers in other countries. If anything, a stronger yuan will simply push manufacturers to improve productivity.
But don't expect that to stop the complaints. A policy change now appears inevitable, but it looks set to be an anticlimax that disappoints everybody.
