China’s gambit

- Clever move. "Last Saturday, China announced its intention to (further) enhance the flexibility of its FX regime and to permit an orderly appreciation of the yuan (p. 7-8). The move was, however, more of a political concession ahead of the G-20 summit tomorrow than a material contribution to the sustained reduction of global economic imbalances."
- Appreciation. "It would, namely, be unwise to bet on a rapid and extensive elimination of the pronounced undervaluation of the yuan. The central bank will not permit anything more than a gradual, moderate revaluation of the currency; that is also what investors expect. This expectation is, however, in China’s vested interest, since it will help curb inflationary pressure and permit a rise in real wages."
- Imbalances. As a result, the impact on the real economy will, however, also remain modest. A sustained reduction of the current account imbalances should be expected at best over the medium term. In the short term, China’s gigantic surpluses and the high US deficit will likely even continue to increase (J-curve effect)."
- Side effects. "On top of that, the rest of the world is facing the prospect of potentially higher government bond yields and rising (import) prices. This applies first and foremost to China’s main customer and investment country, the US. China holds 11% of all outstanding Treasuries and, therefore, more US bonds than, for example, US households or the Fed. And the days of imported deflation from China are probably gone forever."
- Homework. "The next move is now up to the US. While China is moving, at last, in the right direction, the US savings rate is falling while the trade deficit is rising again. But as long as the US persists in living beyond its means, reducing global imbalances will fall by the wayside."
- Further topics:
– Weekly Comment: Dispute on consolidation.
– UK: Emergency budget – an assessment.
– EMU: Deleveraging hurts consumption and investment activity.
– Data outlook: Pronounced job losses in the US.
– Market outlook: EUR temporarily stabilizing.
Unicredit Friday Notes 20100625