"This is the way the new world begins Not with a bang but a whimper." (With apologies to T S Eliot)
The long-awaited change in the Chinese currency, the yuan, happened on Thursday. Not over the weekend, when all markets would have been closed, but just an hour before the US market opens. Subtle.
The amount of the revaluation, 2 per cent, was of a magnitude that would not affect the price of anything, let alone tomatoes.
Estimates of the undervaluation of the yuan ranged from about 10-15 per cent to about 40-60 per cent. Of course, there were some who said that China should not move from a fixed exchange rate, but even these experts felt that the yuan was undervalued -- and/or that the Chinese had been playing the mercantilist trade policy for a bit too long.
The world is abuzz with the consequences of this whimper for growth rates, stock prices, commodity prices, interest rates, central bank reserve compositions, in Beijing, in Hanoi, in Brazil, in India, in the United States.
Surely one of the most important financial market events since. I happen to think that this whimper is more momentous than either the East Asian financial crisis of 1997-98 (affected just a handful of countries), or the Black Wednesday in September 1992 (just the pound) or even the Plaza agreement (just the Western economies).
This little reval affects the entire world -- developing economies, those wanting to develop, and the developed economies. If ever proof was needed that a Chinese revaluation was necessary, the reverberations around the world are so.
There were several China apologists arguing that a reval was not necessary; and/or that a flexible exchange rate would bring about a large devaluation of the yuan! No wonder economists are like Hindu gods -- multi-faced and multi-handed!
There is a premise behind the belief that the 2 per cent reval is not the end, not even the beginning of the end, but rather the end of the beginning. The assumption is that the Chinese government will not for a second think that they have done enough to satisfy the demand of the Americans (actually the entire Western world and most of the developing world) to depeg their currency from the US dollar.
They will not for a moment think that now it is business as usual and Unocal is in the bag. They will not for a pal (the smallest unit of time) think that the US Congress will be satisfied with their fleeting reval and will no longer impose China-specific tariffs.
What will it take to satisfy the world that a fair yuan/$ exchange rate (approximated by a free exchange rate) is the target? Not what would be a modern version of Chinese torture: a .01 per cent reval tomorrow, a .1 per cent reval in 2.5 months and a 1 per cent reval in a year.
In this scenario, China's Thursday move would be the first one in a messy trade war; messy primarily for China, which has likely realised that it is not just the US that believes that its currency is massively out of line.
What will do the trick is that with the predictable volatility of central bankers (they like going home with the notion that they have "surprised" the market -- to each their little bits of happiness), the yuan will have appreciated by about 10 per cent by next July.
What about the other big two, $/yen and $/euro? The initial reaction of the market is that these currencies should also rally against the dollar. If so, the net effect will be that the yuan has appreciated somewhat against the dollar and depreciated against the other majors, i.e. all that a reval has done is to change the direction of Chinese exports to Europe and Japan.
The Chinese juggernaut will continue till European and Japanese growth rates are reduced to zero. So what, the consumers will have cheap goods, and interest rates will be lower so that the Europeans can buy more expensive houses! Far be it for me to argue against the market, but I would bet that it has got this side of the equation wrong.
The new beginning has the Chinese currency appreciating with respect to the rest of the world; payback time, if you will, for the mercantilist policies of deep undervaluation of the last 15 years -- since the devaluation in 1989 (and in 1993). More appreciation with the Western world than with Asia, but some appreciation versus Asia as well.
Several parts of Asia (especially Korea and India) have already appreciated with respect to the US dollar (quite significantly, in real terms, over the last couple of years). In the new world order, growth gets redistributed from China to other countries, with some much-needed "extra" growth coming the way of Europe and Japan.
What about the Indian rupee, and Indian growth? The rupee will remain under pressure to appreciate, and the Reserve Bank is expected to manage the currency in an expected brilliant fashion, e.g. not let it appreciate much -- say, a fifth of the amount that the yuan revalues.
In terms of growth, the timing of the China reval could not have been better: we have been on the verge of attaining our long-held quest of 8 per cent growth for some time. Maybe now we will achieve it, and the left over politicians will not be able to stop it.
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