Spot the Three Currency Regimes

• The hypothetical basket is composed 75% of US dollars. Probably some of that weight belongs to currencies highly correlated with the US dollar, but the model picks the US dollar.
• The yuan has been artificially appreciated versus the basket Over the past month and a half by 0.5%. If all of the currencies in the basket were revalued equally, the dollar would be 8.133 yuan, as compared to 8.092 today. (Wouldn’t Washington squawk if the exchange rate actually fell below the initial devalued level?)

This may explain the recent move by China to change the currency bands for all currencies except the US dollar. It was getting too hard to do a controlled appreciation of the yuan versus the dollar while staying within their currency bands for the other currencies; it’s impossible to have more than one set of cross rates globally.

My guess here is that China is trying to please Washington in a slow way, but retain the benefits (to the government, and those connected with it) of a managed currency. Investment implication: business as usual in China; neo-mercantilism continues for now.

Position: none

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For those that missed my logic at the time of the devaluation, China kept its currency fixed to the US Dollar until mid-2005, then appreciated it in a dirty float until mid-2008. Since then it has returned to a dirty fixed rate versus the US Dollar. Note that the last regime shift fits with when things really began to turn down in the global economy.

Make no mistake, China’s currency has been managed since 2005. Timothy Geithner was correct when he said in his written responses to the Senate:

President Obama – backed by the conclusions of a broad range of economists – believes that China is manipulating its currency. President Obama has pledged as President to use aggressively all the diplomatic avenues open to him to seek change in China’s currency practices.

Now, it was a mistake and impolitic to say that. Given all the money that China has loaned the US in US Dollars, you don’t want to let the sucker know how badly he has lost money bite the hand that feeds you. We need to send economic policymakers to media school so that they can know how their statements affect markets and foreign relations. Learning on the job wears on us all.

I don’t have a big point here, except to say:

• China’s currency policy changed in mid-2008.
• China never let its currency float, even against a basket.
• Timothy Geithner needs to consider his words more carefully.
• We need to consider what a pseudo-fixed exchange rate implies for economic matters.

Personally, I don’t think that China keeping its currency artificially cheap can work in the intermediate-term. But the Chinese Government does not think in terms other than what benefits their long-term control over China. Other things can and will be sacrificed. But maintaining control over domestic affairs matters greatly to the Chinese Government, and all foreign affaqirs must bow to that.

The pseudo-fixed exchange rate will require increased purchases of US assets, relative to an appreciating Yuan regime. Perhaps we should be grateful for that. If so, we haven’t seen any benefits, and neither hasw China.

I wish I could give a crunchier conclusion here, but I can’t. In our deflationary world, the temptations toward protectionism, even through currency policy, are significant. It is no surprise that we are seeing this change now.

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Well, we are in regime four now as the Yuan strengthens again, but again, it proceeds at its own pace, and resembles a “crawling peg” against the dollar, ignoring all other currencies.

China makes noise about modernizing their financial system, but without real financial reform, where the main banks are no longer wards of the state, there is little hope that that will happen.