For most of its history, the Chinese Yuan has been pegged to the US Dollar. The currency underwent a dramatic devaluation as China began to liberalize its economy from 1980 through the first half of the 1990s. From the mid 1990s through 2005 the peg to the US Dollar remained relatively stable. However, as China’s export power surged in the late 1990s and into this decade, the country faced growing pressure from not only the US, but many of its trade partners, to allow the Yuan to appreciate. In July 2005 the country shelved the US Dollar peg in favor of a “dirty float” in which the currency was managed against a basket of currencies, allowing it to float modestly. Over the subsequent three years the Yuan appreciated approximately 17.50% before the Chinese government, in the midst of the global credit crisis, essentially re-pegged the currency directly to the US Dollar. In June of this year, China announced that it would once again allow the Yuan to float modestly and the currency has appreciated approximately 2.5% since then.
While China is unlikely to allow the Yuan to appreciate rapidly, it is very likely to allow it to appreciate at a somewhat faster pace than it did from July 2005 through July 2008. They will do so not so much due to political pressure from trade partners, but due to the demands of their own economy. Pegging the Yuan to the US Dollar means importing easy US monetary policy, something the rapidly growing Chinese economy can ill afford to do. In October, Chinese consumer prices were 4.4% higher than they had been a year earlier; the fastest pace of consumer price inflation in two years. In September, property values were 9.1% higher than in September of 2009. The last thing the Chinese economy needs is US style monetary ease. While the world is familiar with China’s export prowess, most investors are less aware that despite China’s enormous current account surplus, the country is also a massive importer. According to the CIA Factbook, China trailed only the EU, the US, and Germany as the world’s largest importer in 2009. The country is a major importer of oil, metals, and most recently, agricultural goods, all of which are priced globally in US Dollars. Allowing the Yuan to strengthen against the Dollar would reduce the price inflation associated with the country’s imports.
Of course Yuan appreciation is not a panacea. The country is already fertile ground for foreign direct investment and a rapidly appreciating Yuan would almost surely ignite asset bubbles. Yet a moderate, consistent, upward re-valuation of the Chinese currency would benefit both the Chinese and the global economy, a fact which the Chinese government appears to be well aware. As such, one should expect further liberalization of Chinese currency policy and additional appreciation of the Yuan over the next three to five years.