So Much For That RMB Revaluation. Thanks A Lot, Greece!

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The pain of the European debt crisis is spreading, with the plummeting euro making Chinese companies less competitive in Europe, their largest market, and complicating any move to break the Chinese currency’s peg to the dollar.

Another excellent article by Keith Bradsher at the New York Times.

The RMB revaluation journey has been a long and strange one over the past seven years or so. Most of the attention has been on the U.S.-China bilateral relationship, the bilateral trade deficit, and the employment effects of related policy on both sides.

The U.S. call for RMB revaluation has been fairly steady, although louder pleas occur around election time and when the U.S. economy runs into problems. The most recent spike has been the result of the Great Recession and persistent U.S. unemployment. The usual suspects in Congress (e.g. Senators Schumer and Graham) have been up to their old tricks sponsoring punitive legislation.

In conjunction with recent negotiations on the Iran nuclear program and international economic sanctions, most people seemed convinced that some sort of revaluation was in the cards, either a modest one-off bump upwards or a gradual relaxation of the trading band that would allow the RMB to float upward over time.

Enter the Greek debt crisis.

Chinese policy makers reached a consensus last month about dropping the dollar peg. But allowing the renminbi, the Chinese currency that is also known as the yuan, to rise against the dollar now would mean a further increase in the renminbi’s level against the euro, creating even more problems for Chinese exporters to Europe.

The thing to remember about international monetary policy is that it’s, well, international. Just because one country, like China, pegs its currency to that of another country, the U.S., that doesn’t mean that other nations are not affected by changes in that money’s value.

In the case of Greece and the Euro, the reverse is true, and events in Europe are having a direct effect on China’s monetary position. What’s happening out there? Greece was on the verge of bankruptcy and the situation is still dire. The discussion over Greek debt has included debates on whether it should stay in the Eurozone at all, and even whether the EU, or Eurozone, itself is a deeply flawed institution. More recently, EU Member States have agreed upon a bailout package.

Well, you can imagine that such talk, not to mention underlying financial realities, have pushed down the value of the Euro. Who wants Euros, and who wants to do business in Europe, under these circumstances?

So the Eurodollar rate has gone down the toilet. A picture is worth a thousand words, though, so feast your eyes on the carnage:

Euro-Dollar Rate (last six months)

Nasty stuff. More important, though, keep in mind that whole “international” thing. This does not just affect the U.S. and Euroland. The RMB is pegged to the dollar, so whatever the dollar experiences against other currencies is also mirrored by the RMB. (To be more precise, the RMB’s value against the dollar is kept within a narrow trading band, not a fixed peg.)

As the above chart shows, the Euro has taken a beating against the dollar, meaning that the dollar is stronger now than it was before. This means that dollar assets are worth more in Euros; Americans that still have jobs are once again considering European vacations.

Euro-Yuan Rate (last six months)

Euro-Yuan Rate (last six months)

To close the loop, remember that whatever the dollar experiences against the Euro (i.e. it’s a lot stronger now) is mirrored by the RMB.

So now the RMB is stronger against the Euro than it was a few months ago.

The euro has plunged against the renminbi in recent weeks, at one point Monday reaching its lowest level since late 2002 before turning higher.

“The yuan has risen about 14.5 percent against the euro during the past four months, which will increase cost pressure for Chinese exporters and also have a negative impact on China’s exports to European countries,” the [Commerce] ministry official, Yao Jian, said at a news conference in Beijing, according to news service reports.

What’s the connection to exports? A basic trading illustration would look a bit different depending on the currency of the deal, so let’s assume that a Chinese factory is selling shipments of widgets to a European distributor, and each shipment has a price of 50,000 Euros.

At the end of November, 50,000 Euros was equal to about 515,000 RMB. Fast forward to now, and the Greek crisis, and that same shipment priced in Euros is now worth 420,000 RMB.

It’s a little more complicated than that, but essentially what it all means is the Chinese factory is either getting less money for his widgets or he is selling fewer widgets. To the Chinese government, that means less money coming in to the export sector, which is just now bouncing back from 2008/2009 when the bottom temporarily dropped out of global trade, and ultimately less jobs.

Going back to the U.S.-China debate over the value of the RMB, which looked to be heading in the right direction, the situation has now changed. If China relents to pressure from Washington, the result is a strengthening of the value of the RMB. This means Chinese goods to the U.S. become more expensive — basically the same dynamic I illustrated above with the widget purchase.

China’s export sector is already unhappy about its position due to the Euro, but to take a contemporaneous hit on the trade front with respect to the U.S. market? That’s a bitter pill that Beijing is unlikely to swallow anytime soon or, to further the analogy, at least not in a large dosage (i.e. a sizable revaluation).

2 responses on “So Much For That RMB Revaluation. Thanks A Lot, Greece!

  1. Jesse Covner

    I read the same article. I was not going to write about it in my blog because I’m not an economist. But you managed to put in a little “econ 101” which was very helpful.

    Question: Does not devaluation of the dollar also devalue the huge amount of US denominated debt which China owns (ie. US Treasury Bonds)? And if so, what repercussions would take place if the US Dollar assets owned by China devalues at the same rate as the Euro (i.e. 14.5%)?

    1. Stan Post author

      That’s a bit confusing, not to mention outside of my comfort zone. I can say, though, that the dollar was going down the tubes for a while before it bounced back during the recession (when money went into T-bills as a safe haven). With devaluation, you are correct, China’s assets are also devalued. That’s one of the reasons China was complaining so much a while back about being “stuck” with the dollar.

      Your hypothetical states that the dollar and the Euro are devaluing at the same rate? Highly unlikely. That would take care of a lot of the major economic activity in the world (EU, US, PRC), so at least that part would sort of be a wash. Pretty much the only other folks to worry about at that point would be the Japanese. Am I missing your point?