China's Monetary Report: Revaluation Will Be Gradual

China's central bank issued a 2005 fourth quarter monetary report (the report is here, but it's not yet available in English). The report makes clear that China isn't changing its position on managing its exchange rate, at least not in its public pronouncements. They are working on building a system that will support more flexibility, but the yuan will float when market conditions within China dictate it, and not before. Will saying they are committed to improving the exchange rate system be enough? It's now Washington's move:

China rebuffs US call for faster revaluation, by Richard McGregor, Financial Times: Beijing has rebuffed renewed US demands for a faster acceleration of its currency, saying it would maintain its policy of “gradualism” in building a flexible system suited to the development of its own economy. A statement published on the website of the central bank, the People’s Bank of China, part of its quarterly survey of the economy, said Beijing would maintain a “basically stable” renminbi.

This phrase, often used by the government, is code for Beijing’s priority of bedding down reforms to its currency system at a pace that will allow traders and enterprises to adjust to a new regime before allowing a freer float. The government wants to avoid surprises for enterprises that have little experience in managing currency risk and build expertise in foreign exchange markets prone to speculation. “We will perfect the managed floating exchange rate system based on China’s needs for economic and financial development and stability,” the bank said in its statement. ...

And, from The Standard in Hong Kong, more on the monetary report:

Yuan to be kept stable in growth slowdown, by Greg Yang, The Standard: Beijing will keep the exchange rate of the country's currency at a stable level this year, while economic growth is expected to slow, the People's Bank of China said. The yuan will be kept at a reasonable and balanced level this year, with market forces playing a fundamental role in determining the exchange rate, the central bank said in its 2005 fourth- quarter monetary report Tuesday. ... "We'll optimize the managed-floating exchange rate system and widen the channels for capitals to flow out of the country," the bank said...

The economy's excessive reliance on export and investment has become a major problem for China's economic development, the bank said.  Fixed-asset investment and exports contributed 48.8 percent and 17.9 percent, respectively, of GDP growth last year... China ... has set a GDP growth target of 8 percent for this year, down from last year's 9.9 percent, the bank said. "The central bank is always conservative on releasing the full-year GDP target at the beginning of every year," said Standard Chartered economist Tai Hui in Hong Kong. "The final result shall be higher." ...

"The central bank obviously sees inflation to go up, not down, despite concerns about deflation risks by some economists and officials," said Citigroup economist Huang Yiping in Hong Kong. "The expected pickup of inflation would further strengthen the case for more tightening." China has tightened lending to some overheated sectors such as steel...

Monetary policy within the U.S. has one objective, domestic well-being. The Fed does not consider, except to the extent it feeds back to the U.S., the impact of its monetary policy decisions on other countries. That is not within its mandate. The Chinese central bank is no different. It is not its job to worry about economic conditions within the U.S., its job is to promote domestic stability and the bank intends to do that by stabilizing the exchange rate irrespective of our protestations. I doubt the Fed would follow the wishes of Chinese politicians and policymakers if the situation were reversed.

So what is our solution? We have our purchasing power to play against China's fear of political unrest from economic instability. We can threaten protectionist measures and that is fine so long as the threat works and we do not have to actually put the tariffs or quotas in place. But what if our bluff is called? A trade war is not in either country's long-run interests. A more difficult but better solution is to convince the Chinese that it is in their best economic interest to allow the yuan to float sooner rather than later, an approach that requires effective persuasion rather than effective threats. But patience does have its limits.