China gets a big bang for a tiny change in its yuan-dollar peg

06/21/2010 9:59 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Score it “Stability” 4, “Flexibility” 3.

That’s the count for how many times China used each word in announcing that it would end the peg that kept the price of its currency fixed to the price of the U.S. dollar.

China made it very clear, I think, that an end to the absolute peg means a move to a managed peg that will keep the yuan’s appreciation against the dollar to something in the range of the 3% that financial markets anticipated for 2010.

So why the huge rally in Asian—and other stocks--this morning?

Relief that the global economy has dodged a trade war at a time when the recovery is looking especially vulnerable.

In the run up to next week’s G20 economic conference in Toronto, China and the U.S. Congress looked like they might be headed to a collision with U.S. politicos such as New York Senator Charles Schumer (Dem.) threatening trade sanctions in retaliation for what he called “unfair trading practices.” The Obama administration seemed, if not exactly on board, to be increasingly willing to use the threat of Congressional action to pressure the Chinese, but there was no certainty that China would change any of its policies.

By moving now in advance of the G20 meeting China has avoided a collision that financial markets feared would turn into a nasty tit-for-tat trade war. Hence today’s rally.

Two points worth making at this juncture:

First, China’s language indicates a very limited and very slow appreciation of the yuan against the dollar. I don’t think the change will have a noticeable positive effect on U.S. companies selling into China. The currency exchange rate is only one—and perhaps the easiest to address—barrier to U.S. exports to China. Other barriers such as government buying preferences, local content laws, and controls on foreign investment in Chinese companies are much bigger barriers—and they all remain. The biggest winners on this, and this is reflected in today’s rally—are those Asia exporting countries that compete with China and that were getting savaged by the appreciation of their currencies against a yuan pegged to the U.S. dollar.

Second, by making this change before the G20 meets, China has taken the yuan exchange rate, if not off the agenda, at least off the top of the agenda. China would like to focus the meeting on the need for developed countries to reduce their budget deficits. And with the yuan no longer pegged to the dollar China is likely to get its wish on that.

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