Eye on China: Revaluation just a ritual courtship

The yuan revaluation two weeks ago has created a frenzy of speculation about the significance of the move.

In fact, like an elaborate courting ritual, the yuan revaluation - to 8.11 against the US dollar, but with reference to a basket of currencies - is just one more flirtatious wink from one partner to another, elements of an increasingly complicated trade and geopolitical relationship.

Like any good flirtation, it contains the promise of more to come, while keeping the specifics to a minimum.

The two partners involved in this game are, above all, the domestic audiences of the US and China.

Following the move, the US can tell its workers worried about the China threat that Uncle Sam has once again been able to browbeat a pesky Asian upstart into submission.

After all, what's the point of being the world's only superpower if you can't throw your weight around?

For China, the result has been to ward off the worst of US anger with a minimum of concessions.

That ensures that a proud nation avoids the appearance of buckling to hated outside pressure. The decision to replace the US dollar by a basket of currencies also merits respect: What better way to hint to the arrogant Americans that the US dollar is not the only game in town?

Even more chilling for the deficit-ridden US is the message that China, under the new, multi-currency regime, could diversify out of US dollar investment instruments.

China, the second-largest buyer (after Japan) of the US bonds which finance the US deficit, could be signalling that the new currency regime means it will diversify its huge forex reserves into other major currencies, with potentially catastrophic consequences for the US dollar.

The extent of the appreciation, 2.1 per cent, is far lower than any Hong Kong investment banking analyst had predicted (which was a minimum of 5 per cent as a first step, although many bank economists are now claiming that they meant 5 per cent by the end of the year, if necessary in several stages).

That is a minimal response to the months of US pressure to revalue the yuan.

China used clever theatrics to make the move a lot more exciting than it actually was. Many Hong Kong-based China watchers were on holiday and the announcement caused chaos as bankers trapped in holiday resorts and airports thrashed about to put out comments.

The information vacuum succeeded in creating an increasingly desperate demand for clarification, which gave the issue a higher profile than it deserved.

The Chinese central bank announced the yuan would be permitted to rise 0.3 per cent a day. That's huge. It would take just a few months for the currency to appreciate by the 25 per cent to 30 per cent margin by which many economists say it is undervalued.

But in practice the central bank has intervened firmly in the market since the launch of the new regime to keep the currency trading close to the 8.11 level at which it was reset.

Thus, despite pent-up market demand, the yuan had only strengthened to 8.1056 by Friday, much less than its mandated limit.

The smoke and mirrors go further. Only the most bone-headed American could have failed to realise by now that the undervalued yuan is not the principal cause of the US$162 billion trade deficit with China.

The trade deficit is rooted in the budget deficits the US started running in the 1990s. These deficits were simply the result of the US outspending its own shrinking pool of savings, causing interest rates to rise, and thereby attracting the foreign capital necessary to replace the dearth of domestic savings. But a stronger currency (thanks to the higher rates) meant foreign goods became cheaper in US dollar terms and that fed the trade deficit.

Americans don't seem to understand that their trade deficit is the reflection of their own strong growth in recent years - growth based on a model which substitutes US savings with foreign capital. The best way they could cut their deficit with the outside world would be to slow growth, but what politician wants to do that?

There are numerous other reasons why the revaluation won't help. The most frequent argument in favour of the new system is that continued appreciation will make Chinese goods more expensive in the US. In fact, the domestic value added of Chinese exports is only 15 per cent - that is to say, most of the value of Chinese exports comes from foreign imports. A stronger yuan will reduce the cost of imports by the same amount as it increases the cost of exports, leaving the net cost of Chinese exports unchanged.

No matter. The most important thing is that the domestic audiences will get the right message about the skill and toughness of their respective governments.

China has little intention to radically change a currency regime which has accompanied 10 years of explosive growth. The US knows that but still requires, and obtains, some symbolic concessions.

As with flirting, both countries can strut and posture safe in the knowledge it's all a harmless game.

* The writer remains anonymous to protect his position in China.