End Is in Sight for China's Currency Peg

04/06/2010 4:47 pm EST

Focus: BONDS

Jim Jubak

Founder and Editor, JubakPicks.com

It looks like the fix is in.

The governments in Beijing and Washington look like they’re figured out a formula that will lead, sooner rather than later, to an end to the renminbi/dollar peg and the appreciation of China’s currency versus the dollar.

Sooner, I’d say, is this summer. Maybe as early as June. The twelve-month, non-deliverable forward market in Hong Kong is pricing in a climb in the renminbi to 6.6346 to the dollar from the current peg at 6.8258.

The latest addition to the formula is a postponement, announced by Treasury Secretary Tim Geithner on April 3, of the April 15 deadline for an annual review that might have wound up branding China as a “currency manipulator.” Needless to say, that would have put a crimp in the April 12 visit of Chinese President Hu Jintao to Washington to attend a summit on nuclear security. US President Barack Obama and Hu are expected to meet outside the summit to talk over bilateral issues such as China’s support for tougher sanctions on Iran and US arms sales to Taiwan.

In the days before the Geithner announcement, Chinese officials had indicated that the meeting could lead to productive discussions on issues of mutual interest if the US was willing to recognize China’s special interest in Tibet and Taiwan. Those unnamed issues of mutual interest certainly included exchange rates. It’s by no means clear to me what kind of recognition China is looking for, or that the US is prepared to deliver.

The odds are that the Chinese will exploit the opening that the US non-action on the currency manipulation review affords because it is increasingly to China’s advantage to end the peg. There are no signs that steps taken to date are working to slow growth in China’s economy. With some economists predicting better-than-10% growth for China’s economy in the first quarter, fears that inflation will run out of control are growing in Beijing. It would certainly be easier to fight inflation and lower growth if a slightly more expensive renminbi lowered the price of imports for Chinese consumers and manufacturers and raised the price of China’s exports to overseas customers. (For more on China’s growth problem, see this recent post.)

Ending the renminbi/dollar peg, which has been in effect since July 2008, would also slow the flow of hot money into China from speculators betting on an appreciation of the renminbi.

The gradual 2% to 3% appreciation of the renminbi against the dollar—which is all China is likely to permit in the first 12 months after ending the peg—won’t have much actual real world effect on China’s exports or on imports into China. But an end to the peg could give a psychological boost to the shares of companies that compete with Chinese exporters and to shares of companies that sell in China. A stronger renminbi means that every renminbi-denominated sale in China translates into more dollars on the balance sheet for US-based companies.

Full disclosure: I don’t own shares of any company mentioned in this post.

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