China is apparently moving with extreme caution towards a modest revaluation of the renminbi. The government continues to drop hints that there will soon be a new fix some 5-10% higher than the longstanding Rmb8.3 rate. It fears the effects of a more dramatic move on the Chinese economy. But the caution may be counterproductive.

The government’s economic and political logic is certainly plausible. A big revaluation would probably provoke China’s exporters to cut jobs and wages. And that could spur social unrest in a country that has a huge supply of underemployed labour.

But financial markets have their own momentum. Traders would know that a 5-10% revaluation cannot do much to reduce China’s trade surplus with the US. Political pressure for another move would start almost immediately. And the traders would have hard evidence that the Chinese were willing to move. The likely response would be a flood of hot money into the renminbi.

Of course, China has capital controls to keep speculators out. But they are rather like the Great Wall - not quite as formidable as they look. China welcomes inward investment, especially from overseas Chinese. Filtering the “good” from the “bad” is already hard. When speculators have seen one inadequate move, they would be likely to try harder.

In short, an attempt to shift the currency a little bit might end with the Chinese authorities capitulating. Fair value for the renminbi is estimated to be 15-30% higher than the current level. But in such a scenario, it would probably overshoot.

Far better for China to act decisively and revalue the currency properly in the first place. That would mean shifting the rate by about 20%. A jump of that magnitude would not only calm down the US, which is threatening trade sanctions if there isn’t a revaluation; it would also take the wind out of the speculators’ sails.

There is, of course, no indication that Beijing is contemplating such a bold move. But, then, surprise is crucial to such a shock strategy. If that were the government’s intention, it would not be letting

Copyright ? breakingviews Author: Edward Hadas

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Context News

The US Treasury said that China could be liable to trade sanctions as a currency manipulator if there is no revaluation in the next six months. It called the fixed Chinese exchange rate “a substantial distortion to world markets”. The US Senate voted on April 9 in favour of retaining an amendment to the foreign affairs bill that threatens China with the imposition of a 28% tariff on all direct and indirect imports.

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