07/21/05 by Chuck Butler
“Public Announcement of the People’s Bank of China on Reforming the RMB Exchange Rate Regime.”
This was the announcement that came across the screens this morning. Finally! China had announced that they no longer would peg the renminbi to the dollar. This had been the news that investors have waited for over two years to hear. The “floating currencies” of Asia are moving stronger vs. the dollar on the news, and should continue as this new renminbi exchange rate regime unfolds.
I view this move by the People’s Bank of China (PBOC) as simply symbolic at this point, as the (PBOC) gets to soothe the feathers of the U.S., and slam the door on the fingers of the currency speculators. However, as I’ve explained to our customers in the past… This will lead to other currencies in the region to allow their currencies to gain vs. the dollar. We’ve already seen evidence of this in the announcement by Malaysia that they would also drop their currency peg to the dollar!
Here’s the skinny on the move…
Starting today, China will reform the exchange rate regime by moving into a managed float exchange rate regime based on market supply and demand with reference to a basket of currencies. Renminbi will no longer be pegged to the U.S. dollar.
There is no word at this point regarding the mix and weightings of the currencies in their new basket. I would think that a mix of 20% yen, 20% euro, 20% dollars, with other trading partner currencies making up the difference as a good start. If the final basket looks like this, I would think that yen, euro and other trading partner currencies would benefit greatly, while dollars would be sold, bringing the dollar back to the underlying weak dollar trend.
In addition, I don’t think that the influence on the floating Asian currencies, like, Japanese yen, Singapore dollars, and Thai baht, can be downplayed one iota. Recently, these currencies have been pressured by the dollar due to Fed tightening and higher oil prices. I think that now that this move has been made by China, the markets’ overall focus can be readjusted to the massive U.S. Current Account Deficit, and how a weaker dollar vs. these Asian currencies can go a long way toward a correction in the Current Account.
We should not only look for currencies to move on this announcement, U.S. Treasuries should see some pressure due to the fact that China’s currency change could lead them to buy fewer Treasuries going forward.
And finally, should this move not achieve the currency movement that the U.S. government wants to see, I would expect the U.S. government to re-apply the pressure for further moves by the Chinese.
