Saturday, July 28, 2007

Will China finally let its currency float in 2009?

Liberal politicians like to complain that China is "manipulating" its currency, saying that it "hurts" U.S. manufacturers who are trying to compete with cheap Chinese goods.For the most part this has simply been talk along with meaningless votes in Congress as the business-oriented administration has resisted these liberal efforts to "punish" China in a manner which would punish Americans in an even worse manner. But with the election coming up in 2008, with Hillary poised to win, with Hillary and others passionately committed to fighting China's currency "manipulation" as an election theme, and some stronger action against China and its currency likely from Congress and the new administration when it comes into office in 2009, it becomes very urgent to get a handle on where China is likely to be on foreign exchange rate policy in 2009 as Hillary comes into office and must quickly decide what to really do about the Chinese forex problem.

I do believe that China will eventually float their currency, but the timing is very uncertain. Chinese officials have occasionally stated as much, and I do believe that they understand the necessity of such a move. Right now, their financial system is still much too weak and undeveloped to cope with the "forex wolves" of hedge funds and other traders and speculators who are prepared to deploy vast sums of money to exploit forex arbitrage opportunities. A lot of the calls for a float are simply veiled attempts to open up a new market for speculation rather than a sincere attempt to deal with any alleged harm.

The good news is that China is getting financially stronger and more mature as each year goes by. There is a lot more foreign participation in China's banking system than just two or three years ago. China's stock market is quickly demonstrating an appetite for putting capital at risk.

A float in 2007 is absolutely out of the question.

A float in 2008 is very unlikely, but with the war of words heating up for the 2008 election and even Republican candidates falling all over themselves over who can talk tougher about China on Chinese currency manipulation, I strongly suspect that Chinese officials will really get the message and accelerate the pace of laying the groundwork for a float.

I do not expect China to announce a flotation plan in 2008, but I do expect China to grease the skids for foreign investment and bulking up China's financial system.

Even 2009 might be premature for a smooth floatation, but I do think China will be ready by then and at least be in a position to offer the U.S. a fairly rapid roadmap for a staged flotation over, say, a three year period.

I do expect that the U.S. (most likely led by Hillary) will "demand" that China rapidly end currency "manipulation" in 2009. And I do expect that China will be able to promptly put forward something on the order of a three-year plan that will be at least credible enough and palatable enough to hold off punitive trade sanctions by the U.S.

There will be a lot of foreign investment in China's financial system over the next eighteen months, strengthening it greatly, possibly even bringing it up to a level of robustness that will likely even intimidate all but the largest of forex "wolves."

So, yes, China could be ready to float its currency in 2009, but I think the likely scenario is a partial, staged float with a big first stage in 2009 and with a full float by the end of 2011.

-- Jack Krupansky

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