Since 2005, China had tied its currency, the Renmimbi (RMB), to the U. S. Dollar (USD). That means that it would float–Up or Down–with the Dollar, within a government-controlled daily “band” (margin of flexibility) of plus or minus 0.50%. Many other nations have complained for years that China maintained its currency abnormally low in order to make its exports more attractive on foreign markets.
In its quest for economic respectability, however, China has been suggesting that it wanted to have the Renmimbi considered to be a “reserve currency”, along with the Dollar, Euro, Pound Sterling and Yen. In fact, the International Monetary Fund had been considering adding it to the group. But, that would require having the Chinese currency valued by the markets–and not be arbitrarily managed according to the whims of Beijing.
Last Tuesday, China suddenly “devalued” (lowered the price versus the Dollar) of the Renmimbi by 1.9%; but, more importantly, it did two other things. The Peoples’ Bank of China (its central bank) announced that it would allow the RMB to float with the markets, rather than the USD, and that the band would be widened to plus or minus two percent. That’s quite a move for a managed economy. So, did China make a wise move?
The IMF praised the shift, however unexpected that it was. The U. S. Treasury, on the other hand, thought that the RMB was undervalued to begin with. Since The Great Recession, the global economy has been in the doldrums. Also, given the relative stagnation in Europe, Japan and the U. K, the USD has been the recipient of considerable foreign cash. Perhaps that meant that the Dollar was actually overvalued in terms of the Renmimbi.
Last week, considering both the initial devaluation and the subsequent response, the Chinese Renmimbi had dropped by four percent. This coming week will tell how long the RMB weakness will last; however, in the long term, it was probably a move for the best. As the Chinese economy has grown to be a larger player in world financial markets, it is certainly about time that the RMB was unleashed, as well.
The purpose of this blog post is not to prepare you to jump into the foreign exchange market. That is one, perhaps more than any other, that is for sophisticated investors. Most ForEx transactions usually take place in tens of millions of dollars, and upwards. But, it is good to, at least, have a basic understanding of what is happening now. And no doubt, you have already noticed the recent impact on the financial markets–as well as felt the pain in your own personal and retirement brokerage accounts.
NOTE: The Chinese currency is also occasionally referred to as the Yuan