The Chinese government has been under a great deal of pressure recently to allow the country’s currency to appreciate. The yuan has been on a managed flat regime since July 21, 2005, when it was first taken off its fixed dollar peg. And since that date, the yuan has actually appreciated 9.3% against the dollar. But that has not done much to cool China’s overheated economy. Most market observers agree that the domestic stock market is overpriced and likely nearing the bursting point of a bubble. China’s exports are hitting record highs bringing with them enormous trade surpluses that only exacerbate the trade inequality between the United States and China. US lawmakers have whipped themselves into a frenzy criticizing China and its exchange rate regime (saying the yuan is undervalued).
China has tried to deal with these problems in a variety of ways. Earlier this summer, the government raised the country’s capital gains tax, hoping to cool the stock market rush. Just last night, the central bank raised borrowing and lending costs by 0.27%. But market speculators suggest that in conjunction with the release of that decision, the government also sold large quantities of yuan on the open market. And so between the announcement of the interest rate hike and the close of trading at 5:30 PM in Shanghai, the yuan actually fell 0.14% to 7.5740.
Most analysts believe the yuan is on track to gain in value, however. Standard Chartered Plc, which does 2/3 of its business in Asia, forecasts a gain of 1.9% to 7.42 by the end of this year. By the end of 2008, the yuan should be all the way up to 7.00 per dollar, according to bank forecasts. But the appreciation is expected to be modest in character as the Chinese government is loath to use the currency to manage the economy. An undervalued currency is still too important for the export-driven economy, and inflation and liquidity (while at high levels) are not at crisis points yet. And so look for the yuan to stay undervalued with relation to the dollar for the time being.
Speaking of the US dollar, forex traders saw a consolidation of the currency after Fed Chairman Bernanke’s congressional testimony yesterday. The greenback stemmed its losses and looks as if it has entered a period of relative stabilization. The US dollar might even be ready to break out against the pound, euro and yen in the coming days and weeks. For a more detailed evaluation of those and other popular currency pairs, check out DailyFX.com’s 2007 Third Quarter Forex Market Outlooks.
Bernanke spent a good deal of time on the subprime mortgage crisis, even admitting that the total losses could amount to over $100 billion. But most of his testimony concerned the growth and inflation forecasts for the US economy in 2007. This is in marked contrast to his predecessor as Chairman, Alan Greenspan who loathed forecasts and projections. Bernanke’s style is formatted to a more transparent rendering of Fed decision-making, and this is good news for forex traders. More information and more transparency mean less volatility in the currency markets. Admittedly, a decrease in volatility is less exciting for some traders, but I would gladly sacrifice the excitement (and anxiety) for more safety and security in my investments. Especially since, over the long run, Bernanke’s style is conducive to a more profitable investment strategy.
Posted: July 20th, 2007 under Americas, Asia, Economics, United States Dollar.
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