China's trade surplus - The Economist

Despite the continuing global demand for Chinese products, there is one more element that has been playing a crucial role in ensuring China's trade surplus in the recent years. It's the renminbi - the Chinese currency.

Being an export-heavy nation, China knew that it had to keep its currency lucrative enough for its trading partners. This incentivized China to keep the value of renminbi low and a managed float seemed to be a feasible way. Besides, this also eliminated the level of payment uncertainty from the minds of Chinese exporters and importers.

Benefits of the Managed Float System vis-à-vis the Fixed Exchange Rate Regime

· Ability to ease out the strict capital controls that were in-built into the system to facilitate a fixed exchange rate regime

· Accumulation of low-yielding foreign reserves (compared to other forms of domestic investments within China) due to more demand for renminbi was a major cause of concern under the fixed regime. Along with this, inflationary pressures were always prevalent. With a flexible system the impact of such issues can be reduced as circulation of renminbi within China can be controlled in a better manner.

· Huge exposure to USD (around 50% of GDP) as the primary foreign reserve means that even a marginal drop in the value of USD can be detrimental to the Chinese economy. With flexible regime, this risk can be eliminated to a certain extent as depending on situation, China can take up exposure in other non-US foreign reserves in a better manner.

The Ultimate Goal

From the above discussion it can be seen that China made a smart move to switch from the fixed exchange rate regime of the late nineties to the managed float system in 2006. In the process, renminbi appreciated 21% against the dollar before it was again repegged to the USD in August 2008 in a move to protect Chinese exporters who felt the heat of diminished consumer appetite amidst the global sub-prime crisis ignited in the US. As demand conditions started improving, renminbi was again moved to the managed float system. This move was also seen as a precursor to the People's Bank of China (PBOC) inching towards making renminbi a global reserve currency. Although this is far from reality, China has made progress in inking trade agreements with selected countries and launched a series of currency swap agreements with more than 20 central banks around the world.

China Economic 2015

When their economies ran off the rails in the aftermath of the financial crisis, eurozone countries like Greece, Spain, Portugal and Ireland found themselves trapped in a currency that refused to decline in keeping with their prospects.

China is not caught in that same trap. Ultimately, that's a good thing for everyone.

From the way stock and commodity markets reacted after China's surprise devaluation of the yuan, you might have thought the country's sudden change of heart about its exchange-rate policy was the first step on the road to disaster. But it is also a step that we have wished eurozone nations could take in order to let their downtrodden and less-productive economies begin to revive themselves.

Both of these reactions can't be correct at the same time. In all likelihood, it was the initial reaction to China's action that was wrongheaded.

In fairness, it wasn't so much that the yuan was abruptly reduced by 2 percent against the dollar, or that it continued to slide in the days that followed (though braked by repeated interventions by the Chinese central bank), that spooked the markets. The markets mainly reacted instead to the Beijing authorities' apparent concession that their economy, which they have hitherto bragged is essentially recession-proof, is struggling more than they are willing to let on. But we already knew that.

In fact, China is no more immune to the business cycle than any other country. It is entirely possible, if not likely, that the nation's political and economic rigidity will make the eventual adjustment much more extreme, perhaps on the order of what Japan endured after its property bubble burst at the start of the 1990s.

Economists outside China have debated what served as the immediate catalyst of Beijing's decision to devaluate its currency. There are a variety of potential causes. For instance, China has pursued a bid to get the International Monetary Fund to recognize the yuan as a reserve currency; letting the markets steer the yuan more directly indeed drew cautious praise from the IMF. The devaluation also followed news of decreasing exports and shrinking currency reserves, both of which this move might help.

Nobody will benefit if the wheels fall off the Chinese economic locomotive entirely. So any hint of true flexibility, such as the government's decision to allow the yuan to move toward a more appropriate level, is a good thing. The moaning that immediately arose from some quarters here in the United States about "currency manipulation" and unfair policy is largely bogus. It was the yuan's artificial tie to the dollar, which has appreciated sharply against other European and Asian currencies in countries where China sells most of its goods, that was the true manipulation - and the Chinese were essentially manipulating it to their own detriment. Of course they will stop doing that as soon as it hurts them. At the very least, they will try to mitigate the manipulation's effects.

China almost certainly does not plan to allow big swings in the yuan's value, even now. The yuan's daily trading value is restricted to 2 percent above or below a rate set by the People's Bank of China, and that restriction seems unlikely to change. But by moving that band significantly, Beijing has tacitly admitted a need for a slightly closer correlation between their currency's value and their economy's reality. It's a start.

There is a lot wrong with the Chinese economic and political system. The idea that its economy can only move in one direction is false, and always was. China isn't recession-proof. It's just that anyone in China who has the nerve to declare a recession is in progress, if and when one comes - in fact, that day might already have arrived - is apt to be fired at best, or even jailed. So nobody says it. But that doesn't mean it won't happen anyway.

The Chinese currency adjustment is not exactly what we'd call market-friendly, but at least it is a nod to reality and a constructive step that we would have urged on almost any other nation in similar conditions. If you want to worry about China, there are much better targets for that worry than the overdue and thus-far modest drop in the value of its currency.