Chinese Yuan (RMB)

In the year-to-date, the Chinese Yuan has already appreciated 6.5% against the USD, the fastest pace since the currency was famously revalued three years ago. This upward pressure has been built largely on the continuing inflow of speculative "hot money," which was itself built on the expectation of further interest rate hikes, ostensibly needed to tame inflation. However, the Central Bank of China recently indicated a slight shift in its monetary policy, backing away from fighting inflation in favor of promoting economic growth. At least until after the Olympic Games conclude, China will henceforth ignore inflation, so as not to precipitate a slowdown that could jeopardize the Games.

When China's foreign exchange reserves breached the $1 Trillion mark in November 2006, it was a momentous occasion. Over the following 18 months, however, analysts yawned as the reserves nearly doubled in size. In the month of April, alone, China added an astounding $75 Billion to its stockpile, bringing the total to $1.76 Billion. Analysts attribute this sudden increase to a massive inflow of hot money, as investors seek to profit from both the Yuan's inevitable appreciation and the widening interest rate spread between China and the US. The Central Bank of China also recently announced the official 2007 trade numbers, which reveal a 49% increase in the country's current account surplus, to $370 Billion.

In its semiannual report to Congress, the US Treasury Department once again did not cite China as a currency manipulator. For as long as the Forex Blog has been covering this issue, various interest groups have been pressing the Bush administration on this issue, since the label of currency manipulator would entitle Congress to level punitive trade sanctions. The premise of their argument remains that an artificially cheap RMB is responsible for the decline of the US manufacturing sector and the burgeoning trade deficit, which topped $250 Billion in 2007.

The anecdotal evidence that China is diversifying its forex exposure
away from the Dollar continues to mount. To date, most of the focus has
centered around the Central Bank of China, which is passively
diversifying its reserves into European and higher-risk assets.
Apparently, Chinese exporters are also getting nervous about the impact
of a falling Dollar on their respective bottom lines. The RMB has risen
11% since the beginning of 2007, which means Chinese companies now
receive 11% less on sales to destinations abroad than they did for
equal-priced goods in 2007. As a result, some companies have taken to
quoting prices in Euros or to adjusting Dollar-denominated prices every
few months. Other companies are building assumptions of a more valuable

The lack of fanfare not withstanding, the Chinese Yuan, or RMB, continues to appreciate against the USD. This week, it crossed the psychologically important barrier of 7 RMB/Dollar, a level last seen in the 1990's. Since its revaluation nearly three years ago, the Yuan has risen 16% against the Dollar, a rate which appears to be growing exponentially given the 4.5% rise already notched in 2008. Due to the Dollar's continued weakness against all of the major currencies, the RMB has actually fallen against the Euro over the same period.

Although the Chinese Yuan is ostensibly allowed to fluctuate in value, the reality is that the size of its fluctuations and the pace of its appreciation are tightly controlled by China's Central Bank.  Since its currency is still effectively fixed to the Dollar, China is severely curtailed in its ability to conduct monetary policy and must closely mirror US policy.  Same goes for the rest of Asia, excluding Japan.

China's trade surplus grew 22.6% year-over-year for the month of January, on top of export growth of 26.7%.  If there is any silver lining to what many policymakers would consider bad news, it is that growth in imports is slightly outpacing growth in exports.  Unfortunately, that is unlikely to allay the critics, and there are still many of them.

China's foreign exchange reserves
currently approximate $1.5 Trillion, the majority of which is
denominated in USD.  Moreover, the Central Bank of China earns
interest on every Dollar it adds to its reserves but must also pay
interest on every RMB note that it must issue to offset the Dollars.
Since the Fed began easing monetary policy, the amount of carry (the
difference between what the Central Bank receives on Dollars and pays
on RMB) earned by the Central Bank has completely inverted, such that
it now loses 250 basis points on average for each Dollar exchanged
for RMB.