It is axiomatic in currency markets that central banks are not to be trusted. Their Delphic utterances are picked apart and analyzed but rarely taken at face value. Such skepticism is more than an expression of the cynicism of speculators – it also drives an essential dynamic. Without an accepted truth, there is only fiction – the animating energy of financial markets.
When it comes to the renminbi, the market?s mistrust of People's Bank of China (PBOC) seems somewhat unfair. In the aftermath of the Asian financial crisis, the PBOC pledged not to devalue China's currency and it kept to its word. Last year, when Goldman Sachs and others predicted the renminbi would be revalued, the PBOC "maintained its stability" – exactly as it said it would.
This year, the central bank has altered its language. "China will keep the RMB exchange rate basically stable at an adaptive and equilibrium level," is the new PBOC mantra. The words "adaptive and equilibrium" are key; they mean that at some point in the future, the PBOC fully intends to introduce more flexibility into its exchange rate system. The currency will be allowed to fluctuate in a wider band against the US dollar than is currently permitted.
But it doesn't follow that the renminbi will be revalued, or that it will appreciate after a wider band is introduced. There is little real pressure for the Chinese currency to appreciate – apart from that generated by the consensus among speculators. China actually suffered a trade deficit in January, albeit one of just US$20 million. While it is too early to know if the trend will hold, the mere fact of a trade deficit suggests not appreciation but depreciation.
The inflows of "hot money" – US dollars coming in amid expectation of a revaluation – are the main source of upward pressure on the currency. But after a scare late last year when the central bank temporarily lost the ability to "sterilize" these inflows, the PBOC has regained its poise. The inflow is no longer exerting an unbearable strain on domestic money supply, meaning that the PBOC is unlikely to be forced into a revaluation.
Some observers counter such arguments by saying that Beijing will revalue the renminbi because Washington wants it to. Such statements are not only untrue (Washington asked for greater flexibility in the exchange rate, not a simple revaluation), but also reliant on flawed logic. History suggests that US demands rarely meet meek acquiescence from China.
The likelihood is that China will do roughly what it says. When demand for renminbi and US dollars within China is roughly balanced, it will widen the band – perhaps weighting the Chinese currency against a basket of currencies in the process – and permit market forces to have a greater say in determining the currency's value. When that happens is an open question, but Beijing is in no hurry, according to central bank officials.
But this version is too mundane and credulous for the market to believe. All manner of rumor and speculation will therefore continue to swirl, yielding opportunities to buy and sell.