Monday, 21 June 2010

Some better signs for global adjustment

News breaking over the weekend that China has broken the Reminbi/Dollar exchange rate peg. It has been announced that the regime is to shift to a "crawling peg", where the central bank sets an adjustable target rate with some narrow bands for fluctuation. This is clearly a regime to allow the authorities to attempt an "orderly exchange rate adjustment" - note the inverted commas.

There is some background to this, hardly shocking, news, here and here.

What happens now? Well, the market reaction tells the tale. It is general perception, well founded in my view, that the Reminbi is quite undervalued in real terms (read the above links; in effect Chinese prices are currently set at an artificially low level relative to the rest of the world via the fix on the exchange rate). The Chinese authorities have indicated that rather than allow domestic prices to inflate as the process of adjustment, they are willing to let the exchange rate appreciate.

If this occurs, this should provide much more comfort all around. Less inflationary pressure in China, less deflationary pressure in the rest of the world. Common sense - shock horror.

The path from here is most likely to be one of bumps and detours, particularly as markets test the announced target fluctuation bands of +/-0.5%, but at least this is a positive move that the powers in China recognise the futility and potential destructive consequences of trying to centrally plan their economy - even if they don't like the fact.

No comments: