On the 19/10/10 China surprised investors by raising interest rates. This sparked a worldwide sell-off in stocks, commodities and emerging-markets currencies as investors lowered their expectations for Chinese growth. We have seen growth in China at double digit pace and as a result this is seen as a key driver of the global economy. Independently, it would appear that the global recovery is starting to lose steam with the talk of further quantitative easing from western nations on the way. China, like the rest of the world, had cut interest rates several times between September and December 2008 as the financial crisis took hold. This increase in interest rates is the first since December 2007. One explanation for this is that inflation is at its highest level since November 2008. Meanwhile, raising rates will also aid in restricting lending and at the same time to help cool the economy. Some forecasters are expecting a further two 25 basis point hike over the next 12 months.
At the recent G20 meeting currency was the hot topic of discussion as talk of “currency wars” and protectionism had been high on the agenda in recent weeks. Central to this debate is the political pressure the Chinese Yuan continues to find itself under. China has been openly criticised by the Obama administration of keeping the Yuan undervalued. One reason for the U.S pushing for the Yuan to be revalued is to help deal with its trade deficit. According to government statistics, U.S imports from China were worth $296.4 bn. in 2009 while its exports to China accounted for only $69.5 bn. leaving a deficit of $226.90 bn.
After the G20 meeting, the Chinese Yuan strengthened from its steepest slide in 22 months on the optimism that policy makers will head calls from the US to strengthen the Yuan. US Treasury Secretary Timothy Geithner stated in an interview on the 23/10/10 that Chinese officials understand it is in the interests in both of domestic growth and global economic stability to let the Yuan strengthen.
However, in addition to the redressing global imbalances and pressure from the US, a more domestic case for revaluing the Yuan is starting to emerge. Firstly, China wants to move away from a purely export led economy and move towards a domestic demanded fuelled economy. As a result of China’s record pace of expansion the modestly wealthy workforce have cash to spare. To add to this, a new breed of consumer is growing outside the centres such as Shanghai who desire foreign goods. As a result of a weaker Yuan, it is harder for the Chinese consumer to satisfy this desire. If China is serious about boosting a domestic demand economy it will have to let the Yuan strengthen. This would in turn encourage the companies within China to start importing foreign goods to fuel this demand. This could ultimately have a ripple effect on the whole economy from shipping and transportation to retail and foreign direct investment throughout China.
It will be interesting to see how this situation will develop. Beijing is attempting to cool the economy gradually by raising interest rates and restricting lending, but is this enough? China is certainly making all the right noise and is letting the Yuan appreciate, albeit at a slower pace than what many of its global counterparts would like. With arguably the worst of the global recession behind us, China could well have got its timing right. The need to combat inflation and China’s growing appetite for foreign consumer goods gives the People’s Bank of China an appropriate backdrop to let the Yuan appreciate at a quicker pace. Only time will tell if China is just playing diplomatic lip service or whether it is serious in addressing the global imbalances.
About the Author
Jamie Jemmeson is an MSTA qualified technical analyst and trader at Global Reach Partners. Global Reach Partners is a market leader in supplying commercial forex trading services and hedging strategies including trading Spot Forex.