US Believes Chinese Yuan is Overvalued

Friday, 17 September 2010

It has been a fairly obvious fact over the past few years that the Chinese keep a peg on their currency to the US Dollar. What has been equally apparent however is that as the US dollar has significantly weakened, the peg value has changed very little.

This has led many traders and market technicians to believe that the Chinese Yuan is overvalued. However, whilst the Chinese authorities have largely downplayed these claims, there has now come a point where it has become so obvious that the currency is undervalued – that even the US government has joined the party.

A recent announcement from the Fed has clearly indicated that both the US government and the Fed itself believe that it is time for the Chinese authorities to take a close look at their US dollar peg, and perhaps allow the currency to appreciate as it did earlier in the year. This would surely create a more transparent market; however at the same time it would probably have a negative effect on the exporting sector – which is the all-important market in China.

The reason why the Chinese government wouldn't want the Yuan to appreciate too much can be summed up in a single sentence. That is – for every 100 pips that the Yuan is appreciated, the exporting sector of China faces a slump of 2.5%. That is more than the Japanese exporting economy, and far more than the US or other westernized countries.

This clearly explains the reluctance of the Chinese to appreciate the Yuan fairly.

However, given the latest comments from the US, the Chinese might have to take a realistic look at their currency. The fact of the matter is that if they keep it at the same rate, they face a backlash from the US and the Eurozone – especially if it is proven that the Chinese are using protectionist policies to protect their exporters (it is already fairly obvious that they are doing this, but it might be difficult to prove at the WTO).

Hence, we believe that if the US dollar drops any further, China might actually be forced in to compliance – and this would indeed hurt the Chinese economy as predicted.

As you can see, China is on the tip of a double edged sword. No matter what they do at this point, they are bound to run in to international relations issues in the coming months.

It will certainly be interesting to see how this situation pans out. We will keep you posted if there are any developments in the currency area.