China's yuan set to reverse course
By Kosuke Takahashi
TOKYO - China, faced with factory closures and slowing export growth as the
global economy slows, is apparently prepared to weaken the value of its
currency against the US dollar in defiance of a key policy goal of the United
States, even as US Treasury Secretary Henry Paulson visits Beijing this week.
A weaker yuan, which would signal an about-turn by Beijing after three years of
appreciation, will help to hold down prices of China's exports, raising the
likelihood of further increases in its already contentiously high trade surplus
with the US. At the same time, a lower yuan will make imports to China from the
US more expensive at a time when American workers are fast losing jobs
as factories there close on falling demand at home and abroad.
Paulson is expected to press for a stronger yuan in talks starting in Beijing
on Thursday, just three days after the Chinese currency posted the biggest
decline in value since the nation scrapped a fixed exchange rate in 2005.
The US initially welcomed China's July 2005 decision to remove the peg tying
the value of the yuan to the US dollar and link the yuan instead to a vaguely
defined basket of currencies. Pressure soon grew in Washington, however, for a
faster rate of appreciation as the US trade deficit with China continued to
mount, sucking ever-more dollars into the Chinese treasury.
A body of US legislators, notably Senators Lindsey Graham and Charles Schumer,
and their supporters argue that China has maintained an artificially weak yuan
to give its exports an unfair pricing edge in world markets.
China allowed the pace of yuan appreciation to increase during the first half
of this year, under pressure from US and European countries. But the
appreciation essentially stopped in July, followed by a sharp depreciation in
Paulson, who is in Beijing to take part in the fifth round of the so-called
"Strategic Economic Dialogue (SED)" with China that he initiated in 2006, used
previous such meeting to switch the focus of the gathering from the strength of
the yuan to other issues.
As recently as December 2, Paulson said the Chinese had been "very responsible
partners and stakeholders and have continued to stand by us and stand by our
debt". The 20% appreciation of the yuan against the dollar since 2005 has been
"important and significant".
The apparent reversal of the Chinese policy regarding appreciation now looks
likely to put the yuan back to center stage in the Sino-US relationship, just
when Paulson's authority is weakened as he prepares to leave office in January.
This week, the yuan continually hit the bottom of its permitted daily trading
band, which extends 0.5% on either side of a midpoint. The yuan traded at
6.8838 to the US dollar as of 2.30 pm in Shanghai Thursday, after dropping as
low as 6.8845 and down from 6.8830 on Wednesday. That put the currency near its
lowest since June 17, according to the China Foreign Exchange Trade System. The
currency hit a record high of 6.8099 on September 23.
The yuan may fall to 8.06 per dollar in one year, Lu Zhengwei, an economist at
Industrial Bank Co in Shanghai, told Asia Times Online.
"This is the beginning of the yuan's depreciation," Lu said. "The yuan is set
to reverse course. Its slump signals the central bank has changed its policy to
one of support for a weaker currency. For developing countries such as China,
economic growth prospects are most important. China's exporters are facing
tremendous difficulties. A 10% depreciation would help more of them to
Paulson's leverage on the issue is considered limited as China is already the
biggest foreign holder of US Treasuries, surpassing Japan. In the event of a
dispute, a strong move by China to reduce its Treasury and US corporate debt
holdings could severely undermine already weakening global confidence in the US
financial system. It would also threaten an end to the dollar standard system
from which the US has benefited since the start of the 1944 Bretton Woods
"There is widespread speculation Chinese authorities will change their stance
toward the weaker yuan policy," said Masashi Kurabe, senior assistant general
manager and head of trading group at global markets division for the East Asia
Region at Bank of Tokyo-Mitsubishi UFJ Ltd in Hong Kong, a unit of Japan's
largest publicly traded lender by market value. "So many local companies are in
a rush to buy the dollar. And there are almost no sellers, excluding the
central bank, because those sellers have no need to be in a rush to sell the
dollar for the time being.''
The Chinese currency may move between 6.8 and 7 per dollar in six months on the
spot market, Kurabe said. In the off-shore market, the non-deliverable forward
rate of the yuan would fall further, he said, because of rising speculation
over China's policy shift on the yuan, especially from early 2009.
The yuan may depreciate by more than 6% over the next 12 months according to
Thursday's trade in non-deliverable forwards, which are used to bet on future
yuan moves. That compares with a 2.6% depreciation indicated by trading last
"There has been a lot of attention this week on the recent sharp rise in the US
dollar against the Chinese yuan, raising fears of yuan weakness going forward,"
Ashley Davies, a currency strategist at UBS AG in Singapore, wrote in a client
"Actually, these developments are a logical extension of the [global financial]
crisis, since slowing global growth reduces demand for Chinese exports and
hence the need for Chinese intervention to stop rapid yuan appreciation. If the
US wishes China to continue purchasing Treasuries, it will have to accept that
the Chinese yuan will have to weaken," Davies said. "[T]he days of a
combination of appreciating the Chinese yuan and large-scale purchases of [US]
Treasuries by the Chinese may be over for now - something will have to give."
In September, China surpassed Japan to become the biggest foreign holder of US
Treasury debt, with a total of $585 billion. China's $2 trillion in
foreign-exchange reserves (the world's largest, followed by Japan's $1
trillion), are primarily invested in relatively low-yielding US government debt
and the until recently considered safe debt of Fannie Mae and Freddie Mac, the
two mortgage-finance companies taken over by the US government three months
While speculation at present indicates the scale of any weakening of the yuan
will be small, the global consequences of the policy u-turn could be
"The impact of China's currency devaluation should be very big," said C H Kwan,
a senior fellow at the Nomura Institute of Capital Markets Research, a unit of
Japan's largest brokerage. "It [could] lead to international competition by
currency devaluation - a beggar-my-neighbor policy. It should be hard for China
to do that. For China it should be a move of the last resort."
Competitive devaluations have been cited by some writers as a key cause of the
Great Depression that started in 1929, leading eventually to the onset of World
War II. The 1944 Bretton Woods agreements was originally set out a framework
for financial stability that would reduce the likelihood for competitive
devaluations and laid the foundations for the post-war economic expansion.
As recently as the 1997-98 Asia financial crisis, Beijing was widely praised
for not cutting the value of the yuan as currencies elsewhere in the region
Concern over a currency u-turn comes after China other efforts to boost its
economy. Last week, Beijing cut the benchmark interest rate by the most in 11
years. It has also unveiled a 4 trillion yuan ($586 billion) stimulus plan to
protect the economy from a global recession. China’s economy grew 9% from a
year earlier, the slowest pace in five years, in the third quarter, as exports
fell along with the global economic slump.
China's gross domestic product growth will slow to 8% in the present quarter
from a year earlier, the State Information Center, a think-tank under the
National Development and Reform Commission, said in a report published on
November 27, the lowest quarterly growth since at least the fourth quarter of
"For developing countries like China, an 8% growth is not acceptable,"
Industrial Bank’s Lu said.
China's export growth cooled to 19.2% in October, the slowest pace in four
months, prompting a pledge from Vice Premier Wang Qishan to "take all measures"
to stabilize overseas shipments, Xinhua News Agency said on December 2. That
could lead to a reversal in China's trade surplus.
"There is no such situation that China's trade surplus will keep ballooning, so
the yuan may move around the current level of 6.8 per dollar in one year," Kwan
China's exports to the US increased 6.8%, to $250.4 billion, in the first nine
months of 2008, compared with the same period a year earlier, according to US
Commerce Department figures. US exports to China rose at more than double that
pace, at 17.3% to $55 billion from January through September. That still left a
$195.4 billion trade deficit that some lawmakers argue is hurting American
The US trade deficit with China widened in October to a monthly record $27.8
Kosuke Takahashi is a Tokyo-based journalist. He can be contacted at