Wednesday, March 24, 2010

The Reminimbi is BOTH undervalued and overvalued

China's tragedy is twofold.

The first fact is that China's currency is undervalued from a global perspective and it is therefore coming under increasing pressure to revalue it (upwards). As the undervaluation is deliberate (in order to make exports cheaper), the international pressure is understandable. Whether international pressure is going to succeed is a different matter. It may not even be appropriate for the pressure to succeed, given the following.

The second fact, however, is that China's currency is overvalued from a domestic perspective. The Remnimbi's purchasing power inside China is weak (i.e. there is a huge amount of inflation that is disguised or hidden).

So should the Remnimbi revalue or devalue? In fact, it needs to do both. But the Chinese government cannot afford to do either. If it revalues its currency externally, its exports will become more expensive and therefore reduce, becoming perhaps the straw that breaks its back. Meanwhile, the nakedness of the Chinese emperor will become clear to all as its balance of trade suddenly swings to the red in the next few weeks. The elaborate game that China has been playing to make its exports appear larger than they are, will be exposed.

On the other hand, if China moves to bring the value of its currency into line with internal reality, its own people will find that the illusion so carefully maintained will disappear. As a result, China could find its already-great internal pressures growing intolerable.

As such contradictions come home to roost, pray for China's leaders. The decisions they are making right now will make the difference for China's future - and the world's. Sphere: Related Content

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