So what if China revalues?

(April 25, 2005) China’s competitiveness on the world stage is well known and beginning to irk members of the international trading community. The United States particularly is speaking out more aggressively against China’s currency policies that keep the renminbi pegged to the U.S. dollar, and considering moves to impose trade sanctions.

Although some reports from this weekend suggest the People’s Bank of China might actually respond to the pressure tactics after all these years, Asia watchers say it is highly unlikely that the Chinese government would ever make moves in acquiescence to foreign pressure or a power play.

“Perceptions are quite important,” says Don Reed, president and CEO of Franklin Templeton Investments. “They will not want to be perceived as having been led or pushed by the U.S. or anybody else to revalue their currency. If there’s going to be a revaluation and there are things going on in the U.S., they would do it well before or well after.”

Recently U.S. officials, including Treasury Secretary John Snow, have repeated calls for China to revalue its currency or pull the peg entirely and let the renminbi rise according to market forces. Even Federal Reserve chairman Alan Greenspan weighed in last week, saying the peg is taking a toll on the Chinese economy and must be eased “sooner rather than later.”

Peoples’ Bank of China governor Zhou Xiaochuan reportedly told delegates at the Boao Forum for Asia (BFA) annual conference 2005 that international pressure could force the country to speed up its exchange rate system reforms.

Later reports, however, reiterated the Chinese position that the country is proceeding with preparations needed for reforming the exchange rate, but would implement changes according to its own schedule.

Even if the central bank chose to adjust the currency peg, only a very significant move would change the economics or trade dynamics. “If you’re going to change the comparative advantage that China has, it would have to be a significant move in the currency and that just isn’t going to happen, certainly not in the first round,” says Mark Grammer, vice-president of investments at Mackenzie Financial. “Most likely, they’ll widen the band, maybe 10%, but they won’t free float the currency, that’s for sure. I would find that shocking.”

If and when China does revalue, the U.S. dollar would probably fall and the U.S. Federal Reserve could be forced to raise interest rates in order to stabilize the greenback. The Canadian economy would benefit from a boost in exports and commodities in particular would benefit from the new purchasing power and demand from China. Importers, on the other hand, could suffer if Chinese suppliers remained competitive enough to pass on the additional costs to purchasers.

“That isn’t clear, though,” says Grammer. “That’s probably one of the reasons China is reluctant to raise their currency because it likely means that at least part of that increase in the currency will have to be borne by the actual manufacturers.”

Even if end user prices do increase, he says the biggest threat to North America is inflation.

Filed by Kate McCaffery Advisor.ca, kate.mccaffery@advisor.rogers.com