According to a recent OECD report entitled ‘Looking to 2060: long-term growth prospects for the world’, China is forecast to surpass the Euro Area in a year and the United States by 2016 to become the world’s largest economy. The OECD believes China will experience more than a seven-fold increase in its income per capita by 2060. “The extent of the catch-up is more pronounced in China reflecting the momentum of particularly strong productivity growth and rising capital intensity over the last decade. This will bring China 25% above the current (2011) income level of the United States,” the organisation says.
Is it possible for China to become the world’s largest economic powerhouse without fully liberalising its financial markets to allow the Renminbi to become widely accepted internationally? For those who trade FX, China’s monetary policy is nothing but a paradox. FX traders know only too well that efforts to make the Renminbi more flexible have been painfully slow. In light of the slowdown in its exports, and the subsequent decline of its current account balance, China currently seems reluctant to widen the Renminbi’s trading band. Calls for further currency appreciation have not fallen on deaf ears over the past several years, but have not been answered with the greatest enthusiasm either.
Take a look at Saxo’s infographic on the trade imbalance between China and the US: despite gradual Renminbi appreciation since the fixed peg to the dollar ended in 2005, Chinese exports to the US remain nearly four times greater than US exports to China. The US has accused China of contributing to their bilateral trade imbalance by maintaining the Renminbi at an artificially low level against the USD. Does this mean China has won the currency war? Meanwhile, its current account surplus has allowed it to pile up huge foreign currency reserves…
So what’s the future of the Chinese currency? The supertanker of Chinese Renminbi appreciation has slowed to a crawl and even reversed a little during 2012. This becomes self-fulfilling as the two things that move the currency are trade-related flows – and they have become not so favourable for the Yuan now because of the reduction in the surplus – and speculative flows. It was massively popular to speculate that the currency would strengthen. However, now you could say after a virtually-unchanged year that’s not front-and-centre for a lot of hedge funds. That supertanker could change direction completely if China fell off a cliff, there are rumours of a property collapse, or banks going bust. China could start seeing capital flight if it had an open current account and that’s why it doesn’t – China takes these very gradual steps. So traders who expect the ‘redback’ to soon become the world’s new reserve currency could be disappointed.
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