Renminbi redux.

The Chinese finally decided to let their currency, the renminbi (or yuan), “float” against the U.S. dollar. (For background, please see my prior post: Renminbi revaluation). I put the word float in quotes because it will be highly controlled and not a float in the free market sense.

Political leaders the world over, but especially in the U.S., have been pushing for this revaluation for some time. I doubt it will generate the outcome such leaders hope for. My expectation is higher interest rates and commodity prices in the long run that will eventually make our problems here and abroad worse instead of better.

An interesting question to ask, then, is: why did the Chinese finally do what everyone wanted them to do?

The most obvious answer, and the one that will satisfy most political leaders, is that China bowed to U.S. or international pressure. I doubt that’s the case. Right now the rest of the world depends on China as much as or more so than the other way around.

Another suggestion, mostly from political thinkers, is that China is assuming its position on the world stage and having an independent currency is part of that. Although more feasible than caving to pressure, I think this argument misses the mark, too. I believe China desires a prominent position in the world, but I don’t think it would sacrifice a piece of its low cost edge in order to get it.

No, I think the real reason behind revaluation is inflation in China.

In fighting financial problems over the last decade, the U.S. Federal Reserve has printed a lot of dollars. That printing has led to higher prices, especially for food and the key inputs to production (copper, iron ore, oil, etc.).

This impacts first world countries much less than third world countries. The first world spends somewhere around 20% of their income on such things as food. The third world, including China, however, spends much closer to 60%.

When the price of an apple doubles and it’s less than 20% of your income, you complain a bit, but it doesn’t cause a significant problem.

When the price of food doubles and it’s 60% of your income, you riot in the streets.

That’s the situation I think China is facing. They’d like to keep their currency on par with the dollar to maintain their low cost competitive advantage (with significant margin to spare), but not at the expense of having inflation cripple its poorest people.

I believe China’s goal is to grow to first world standards of living without causing a revolution. That’s a very delicate goal to achieve, especially with centralized planning and in the short time period they want to achieve it.

They won’t get there if their economy slows too much, or if they have high inflation.

I don’t think China is caving to pressure from the west or seeking the prestige of an independent currency. I believe they are walking a tight rope, and inflationary threats were making them lean way too far in one direction.

Revaluation, for them, is a practical economic matter, not purely a political one.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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