The RMB devaluing or responding to the USA raising interest rates
Recently two features about the RMB have been in the headlines.
One is the drop in the value of the RMB against the dollar of about 4pc. It is difficult to be precise because the rates are still moving around, responding to changes in the USA interest rate , and the changes in the basis for valuing the RMB.
In my simple explanation, the USA has raised its interest rates from a long period at zero. This caused many major holders of funds to move their money into the USA to gain advantage of the new returns. It is not only moving money into the dollar to get the new interest rate , which is not a large return, but because investors and speculators expect the dollar to appreciate from the interest rate rise.
So funds move from world markets, especially emerging markets to the US dollar.
This is what happens when you raise interest rates if investors/speculators expect it to lead to investors/speculators moving their funds. This is what happened.
Most currencies moved down against the dollar as it rose, and this increased the pressure on Chinese exports and the RMB. Why? Because the RMB had essentially been pegged mainly to the US dollar.
So as the dollar rose in response to the new interest rate, so the RMB also moved up against those currencies it did trade with.
So the Chinese decided to adjust the RMB rate to keep themselves balanced against those other currencies. The Chinese economy had suffered from allowing others to allow their currencies to decline against a strengthening dollar, while China kept its currency too high. The Chinese have protected their exports without trying to use devaluation to win greater market shares.
Eventually they decided to adjust the basis of their currencies valuation to a new basket, where the US dollar element was almost halved.
This was the second feature. It is called the CFETS exchange rate index. The RMB is now valued against a basket of 13 currencies, which more accurately reflect China’s trade and investment direction.
China needed to separate its exchange rate from the US dollar which was operating on the basis of its own agenda and perceived need to raise interest rates.
The RMB is now at about the 6.50 plus level, up from 6.25 recent levels in 2015.
If the dollar strengthens again because it attracts more funds, or because it again moves towards further rises in its interest rates, we can expect another drop in the RMB rate against the dollar but keeping a balanced rate against other currencies.
So whereas other currencies have devalued against the dollar, and the RMB had not, now the balance is restored.
It is not so much the RMB that has devalued, as the US dollar has revalued. And the RMB has moved away, partially, from the dollar as its basis for value.
The main feature here has been the decision of the USA to raise its interest rates with regard to its own domestic issues.
But it has major global repercussions in a world of floating exchange rates.
These started in 1971 following the French decision to ask the USA for gold in exchange for its dollars which was the basis pledge of gold based currencies – they could always be swopped for gold. No one really expected anyone to do that and it was part of De Gaulle’s French resistance to the USA fighting in Vietnam. The French were displaced there by the USA and this caused some deep tensions.
The upshot was that the USA decided to abandon the gold standard and all currencies floated from then on. It led to a world based on Reaganomics, which decided that debt could be a huge global stimulus, and that is what we now have.
The USA has run huge deficits since then on the basis of its rising exchange rate which enabled them to import cheap consumer goods, especially from Asia, because the dollar made them cheap.
President Obama did declare it his policy to double US exports over 5 years a few years back, but that is very hard to do if the USA raises interest rates and the dollar rises, making US exports cost more, and thereby becoming less attractive.
The USA is caught between two policy directions. The Chinese have responded to that by creating some distance between their currency policy and that of the USA.
What does that mean for the future? The euro is the second biggest currency in the world, followed, at some distance, by sterling and the Japanese Yen.
We shall wait to see what follows. We know that China feels the world exchange rates should move towards a more independent standard rather than be based upon Washington’s decisions. The SDR of the IMF is one such option.
It is clear that the world is transitioning from a $ dominated world into a new world. That could be one world reflecting, as I have said before, two systems. An Asian plus systems and an older US based system. The Euro stands as a major feature, despite its recent challenges, so any new system needs to take that into account.
The USA has been dominant in world trade for over 40 years through the US dollars major share of world trade and investment. It appears that may be changing. But this one period and adjustments will be followed by more adjustments before the tectonic plates settle in some new structures and relationships.
I would guess that this period of adjustment is more likely to last 15-20 years than 2 years. It is not inconceivable that there could be a return to the gold standard, initially across the New Silk Roads.
Much depends on the USA and China finding their way to a new understanding and a new evolution of a new WTO agreement for the world.
At the moment we have TPPA and TTIP facing Asian and developing nation based trade and investment structures. Globalisation should encourage more global structures. The tendency is away from that for the moment. If that tendency increases under a new American President then we shall see more waves.
It is logical that a new world order of trade and investment more spread across nations, and blocs, with larger gdp’s would enhance global trade and investment. But the present system based around Washington will not easily embrace change which might reflect a change in the world orders.
Hence we will have some blustering winds in the months and years ahead.