Expect the Yuan to rise ….

­­­­­­­­but not for yet a while.

There have two major developments in the last 7 days in relation to the competitiveness of the yuan – or renminbi – the currency of China.  The first was the decision by US Treasury Secretary Tim Geithner to reserve judgement on whether the Chinese are manipulating their currency and keeping it low to maintain its export competitiveness.  The second was the meeting over last  weekend of the Chinese government to discuss its plans for the next 5 years of growth and development.  Unlike western economies the Chinese continue to create 5 year plans to guide the economy.  The one now published – the 12^th - covers the years 2011 to 2016.

See Geithner interviewed recently on US TV on the subject at http://seekingalpha.com/article/230168-in-his-own-words-tim-geithner-on-chinese-currency-manipulation

The debate over the value of the yuan has been raging in recent weeks.  In fact it has been a long standing point of disagreement between Washington and Beijing with various levels of diplomatic and political flak being taken and inflicted by both sides.  The latest round has been at the heart of fears that we might see a currency war set in around the globe.

It is clearly the case that the Yuan is under-valued.  An economy that has foreign exchange reserves of $2.75bn and rising is clearly benefitting from a massive trade surplus and preventing outflows of currency from appreciating the exchange rate.  However, the policy makes sense from the Chinese point of view.  The natural economic process that should allow export revenues to drive domestic demand and draw in imports assumes a buoyant domestic economy.  The risk for China is that a dramatic and widespread increase in internal demand may produce inflation rather than growth.  

The details of the 12^th five year plan are becoming clearer to us (see http://news.xinhuanet.com/english2010/china/2010-10/21/c_13567299.htm).  They reflect the next stage in the relentless development of modern China.  The key issue is the use of the ‘R’ word which in this case stands for re-structuring.  The Chinese authorities are setting a course for the next five years that promotes more domestically focused growth implying less emphasis on the export sector, an improvement in the legal system for managing disputes and a push for a more modern and innovation based foundation for growth.  It also implies that as growth shifts from exports towards domestic consumption that there will be a natural appreciation of the Yuan: not because the plans states it but because that is an economic consequence of their plan.

Now all of this is good news – in the long run.  It signals that there will in due be more export opportunities in China for companies based in the West.  The problem is that while the Chinese realize and are implicitly acknowledging the need for a competitive rate for the Yuan, they will not rush to adjust.  The timescale for their plans is five years.  In the West, the pressure for change is more like the next 5 months.  In the meantime there remains plenty of scope for the West to mount competitive currency wars and protectionist policies which are clearly not in our overall interests.