COMMENTARY
Jake's View
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No tears needed for forex losers as the People’s Bank goes about its job with the yuan

The US dollar weakened against major currencies since late 2016 after a long period of strength. The PBOC is at last making practice catch up with policy.

PUBLISHED : Wednesday, 07 June, 2017, 3:02pm
UPDATED : Wednesday, 07 June, 2017, 11:04pm

Over the past ten days , the yuan has appreciated 1.1 per cent against the US dollar in the onshore market ...

Traders believe the measures taken by the PBOC are aimed at crushing speculators who have a bearish outlook on the yuan. -- SCMP, June 6

Forex traders have generally been complaining over the last few days that the People’s Bank of China has been pushing its weight around a bit too heavily to prove that it remains boss of the yuan exchange rate.

But what if the Chinese central bank is actually just doing its job, as it should, in a country where it is accepted that maintaining exchange rate stability is one of the central bank’s jobs?

In that respect, let me cite the two words “Plaza Accord” to anyone who says that exchange rate targeting is not a proper central bank function for big countries.

There never was a more blatant case of it than when the central banks of Germany, Japan and the United States conspired in 1985 to crash the US dollar against the Japanese yen.

The PBOC’s present operations are not even in the same league. Let he who is guiltless throw the first stone.

I think it’s increasingly apparent that the PBOC adopted a policy in mid-2015 of tailoring the yuan’s exchange rate to the broad movements of the US dollar against US trading partners. It continues to do so now, and it doesn’t talk much about it, which is definitely good central bank practice.

The difference is that since the end of last year, the US dollar has weakened against the currencies of most of its trading partners after a long period of strength. The PBOC, which had been slow in matching this trend, is now at last making practice catch up with policy.

My evidence is in the chart. First to the technicalities. The red line represents the broad nominal trade weighted index of the US dollar against its trading partners set to an index basis of 100 for December 30 last year. The blue line is the yuan/US dollar exchange rate set to the same index basis.

Take note here that the values are reversed. A rising red line represents a strengthening US dollar. A rising blue line represents a weakening yuan.

Starting on the left side of the chart, note how the US dollar strengthened very markedly from mid-2014 to early 2015 while the yuan/US dollar rate was kept stable throughout. This stability against the US dollar, however, masked a strengthening yuan against other currencies.

Eventually, the PBOC gave in to the pressure with a sudden devaluation in August 2015 and then began its policy of tracking the US dollar index in reverse.

When the US dollar strengthened, the yuan/US dollar rate weakened to roughly the same extent, thus preserving stability with other currencies.

Now look at the right side of the chart. Here you see general US dollar weakness since the end of last year while the yuan/US$ rate is kept stable.

And then at some point late last month, someone at the PBOC said, “Hey, that US dollar really is weaker. It’s not just a flash in the pan. Let’s get back to where we should have been if we followed our matching policy all along.”

This is what it has decided to do, and what has actually been done, over the last 10 days.

So what we now have with forex traders screaming that the PBOC is flinging its weight around too much is, in my view, not the PBOC acting irresponsibly but just the usual exclamation of pain when forex speculators lose money on their trades and blame others for it.

And I’m crying, oh, such big tears I cry.

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