Nouriel Roubini and Brad Setser appear to have called this one correctly. Simply staggering amounts of hot money have been flowing into China, betting on faster appreciation of the yuan. or better yet, a significant revaluation.
In fact, this level of weight of money would normally be a self-fulfilling prophecy. Hot money is highly stimulative, pushing China’s already uncomfortable inflation rate even higher. And of course, the fastest way to contend with that is to…..let the currency appreciate.
But it isn’t that simple. China’s export sector is already flagging, due to the fall in the dollar and the rise of shipping costs. And the economy may also ease post the Olympics.
Thus Roubini predicted that the Chinese would not revalue the yuan, but would instead let inflation over time create a defacto revaluation (ie, double digit annual price increases in local currency terms will also make good more costly). On Tuesday, Brad Setser speculated that China would slow the pace of yuan appreciation as the growth rates slipped (although, interestingly, Setser thinks the Chinese overestimate the impact of a US slowdown on Chinese growth rates).
On cue, today we have this Bloomberg story, “Yuan Gains to Slow in Second Half, Researcher Says “:
China will slow the yuan’s gains to about 3 percent in the second half of the year to help exporters weather a decline in global demand and rising costs, said Zhang Ming, a researcher at the Chinese Academy of Social Sciences.
The yuan appreciated 6.6 percent against the dollar in the first half, extending its advance to 21 percent since its fixed exchange rate was scrapped in 2005. The strengthening currency has slowed growth in overseas shipments, which expanded by the least in four months in June. Premier Wen Jiabao pledged to keep trade policies stable to help exporters during his visit to Guangdong province from July 19 to July 20.
“The fast appreciation has drawn opposition from exporters and some government departments,” Zhang said in an interview from Beijing. “The government will slow yuan gains as bankruptcies rise in coastal provinces.”
China’s currency will advance 10 percent during 2008, said Zhang, who writes articles on the yuan for the Web site of CASS, the government’s principal research institute on the economy. That would bring it to 6.64 per dollar by the end of the year. The yuan fell 0.1 percent to 6.8288 per dollar in Shanghai today as of 11:28 a.m., from 6.8217 yesterday, according to the China Foreign Exchange Trade System.
Zhang’s forecast is similar to that of traders. Non- deliverable forward contracts, which allow investors to lock in a value for the currency in the future, show the market is betting on a 2.9 percent advance to 6.6385 in six months….
The Ministry of Commerce has urged the cabinet to slow yuan appreciation and raise tax rebates to boost exports, an official at the ministry said on July 14. The official declined to be identified because he isn’t authorized to speak to the media.
Two-thirds of textile manufacturers weren’t profitable in the first five months of this year, Du Yuzhou, President of China Chamber of Commerce for Import and Export of Textiles, said at an industry conference in Shanghai on July 15…
The adjustment in the pace of the yuan’s gains won’t halt its appreciation or stop the central bank from improving the balance of payments, Zhang said. China’s trade surplus narrowed 20.6 percent to $21.4 billion in June from a year earlier, the third straight reduction, the government said July 10.
“A smaller trade surplus is what we are trying to achieve in this exchange-rate reform,” said Zhang. “We can’t give it up just because of the current difficulties. Too many resources have been allocated to the export industry because of the undervalued yuan, making it difficult to boost domestic consumption.”