Currency speculation is more akin to gambling than many people like to make out and speculating on future Chinese government policy is probably in the same league.
China has maintained for a long time that it intends to eventually move to a fully convertible currency but that this can only be achieved through gradual reform. Now, as we near the end of the first quarter of 2004, the ante is being upped and everyone is placing their bets on when and in what form revaluation is going to take place.
On one end of the spectrum, investment bank Goldman Sachs has made headlines with its prediction that a small revaluation upwards will be introduced before the end of this month and the country will have switched its peg from the US dollar to a basket of currencies by the end of the second half. Towards the other end of the poker table is HSBC's chairman, David Eldon, who said he doesn't expect any adjustment at all in the near term.
While front page stories in mid-February in the Chinese-language China Business Post and the English-language Shanghai Daily both predicted a revaluation of 5% within the next month or two, the Chinese government remains adamant that it has no plans to play around with the current peg in the foreseeable future.
Asked in mid-January whether the currency will definitely remain stable, Yao Jingyuan, chief economist and spokesman for China's National Bureau of Statistics, told reporters: "Definitely," and when pushed on whether there were plans to adjust the exchange rate, he said: "No." Following the mid-February China Business Post and Shanghai Daily reports, an unnamed spokesman for China's central bank said "Currently the bank has no specific plans for renminbi changes. There is no timetable for renminbi reform."
But after a period of tough talk from the US in September last year and a subsequent lull, pressure is once again mounting on China to do something about what many see as a currency undervalued by possibly as much as 40%.
From its peak in the autumn of 2000 until mid-February this year the dollar lost nearly half its value against the Euro and as it plummeted it dragged China's renminbi (RMB) down with it. The rest of the world has seen its export competitiveness evaporate as prices are effectively slashed not only on American-made goods but also on China's already ultra-cheap exports. This has annoyed all China's trade partners but especially the US where struggling manufacturers and exporters were supposed to have seen their fortunes (and their tendency to vote Republican) increase as the dollar fell.
American politicians point to China's massive trade surplus with the US as a sign that the currency peg is giving the country an unfair advantage. That surplus, combined with continued strong foreign investment and an influx of speculative 'hot money', pushed China's foreign reserves above US$403 billion at the end of 2003, up 41% from a year earlier. The larger the foreign reserves, the more pressure there is to revalue the currency, firstly because the massive stockpile is seen as a sign that the country has an unfair trade advantage and secondly because a large current account surplus can lead to rapidly rising inflation.
Put simply, this works as follows. Dollars earned by exporters are converted into RMB, which the central bank simply prints. Unless this extra domestic currency is mopped up in some way, the money supply rises, banks increase their lending, and inflation can take off. China's money supply is roaring along (rising 19.6% in 2003, 2.8 percentage points higher than in 2002) and the consumer price index, the main indicator of inflation, rose a year-on-year 3.0% in November and 3.2% in December.
If inflation starts to accelerate then China is more likely to revalue its currency. There are two reasons for this. Firstly, if the RMB goes up then each dollar is worth fewer RMB and there will be less money injected into the system. Secondly, a revaluation would make China-made goods more expensive to the rest of the world and therefore dampen demand, which would in turn slow growth in the foreign reserves. Some analysts believe that a small revaluation might be just the ticket to slow down an economy that is showing signs of overheating.
A revaluation would also benefit the emerging middle classes by giving them greater spending power for their newly feasible trips abroad. And it would give any company procuring raw materials offshore a whole lot more for their Chinese money.
But the government is always sensitive to anything that could tip the social stability scales and is wary of putting too much pressure on the country's export-oriented manufacturing sector ? a prime source of job creation.
The most compelling argument against messing with the exchange rate system is the delicate condition of the state banks, which some predict would not be able to withstand a major shock. Economists point to the recent US$45 billion recapitalization of two of the 'big four' state banks (Bank of China and China Construction Bank) and the fact that it was paid for out of foreign reserves and left in US dollars as evidence that China is not planning an immediate revaluation. If revaluation was imminent it, the argument runs that the money would have been converted to RMB.
For the Americans the pressure applied to China to revalue could backfire if it means that one of their Treasury's best customers decides it is more prudent to convert its bonds into other currencies like Euros. The Treasury might have to lift interest rates in order to attract investors back and that would make mortgages and loans more expensive in the States and hinder the burgeoning US recovery.
According to some US media reports, there has already been a sharp reduction in the portion of China's foreign-currency reserves that it's recycling into Treasuries ? from 54% in 2002, to 40% in the first half of last year and 24% in the final six months of 2003. This has been taken as evidence that the move to a basket of currencies is in the pipeline. Only time will tell, but for now: place your bets.