Will China Actually Allow Its Currency to Float?

by V Kumar in Economics, June 22, 2010

On June 21st, the markets the world over were buoyed by a statement from China that it will allow a more flexible valuation of its currency, the Yuan. Immediately, several Asian currencies appreciated, several over a percent or two. Even without any concrete action by China, a platform has been created where China can allow Yuan to appreciate. The question is, will that happen?

On June 21st, globally, the markets were buoyed by a statement from China that it will allow a more flexible valuation of its currency, the Yuan. Immediately, several Asian currencies appreciated, several over a percent or two. Even without any concrete action by China, a platform has been created where China can allow Yuan to appreciate. The trillion dollar question is – will that actually happen ?

The massive trade surplus of China, the largest that any country has ever experienced in recent history, is largely a result of its artificially undervalued currency. Its trade with United States accounting for over half a trillion US dollars of surplus, year after year, which was then reinvested back into the United States was one of the primary building blocks of the ongoing financial crisis. The stubborn Chinese refusal to allow its currency to be valued by the markets has also been one of the biggest factors obstructing global economic recovery. Hence it comes as no surprise that any news suggesting a possible change in Chinese stance is highly welcomed by the markets and given a huge thumbs up.

Asian markets, currencies rise in anticipation

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Most markets across the world, from Asia to Europe and United States reacted positively to the news. As stocks and commodities rallied with significant gains for the investors, we had almost the whole world thanking China for the good news. Even more reactive were the currency markets. Just the news that the Yuan may float led to an immediate rise in the value of most Asian currencies, including Korean Won, Thai Baht and Indian Rupee. This means that while the Chinese Yuan remains as fixed as ever, its competitive economies are already burdened with a higher valuation of their currencies, affecting their exports competing with China. If that is not a masterstroke, you can bet that you will never see one in your life!

Deciphering the Chinese Statement

Gradually, as the experts try to understand what the Chinese government has actually stated, things are already beginning to look hazy and uncertain.

The phrase used in the statement is not floating, it is only ‘more flexible’. It does not necessarily mean an appreciation. Neither does it make any commitment that it will be left to the markets to determine its value. It only says that it will not be so rigid with reference to the US dollar, and instead will be valued against a basket of currencies – something that many Central banks already do for deciding the narrow band in which want their currencies to stabilise.