China says it is no longer pegging its currency to the U.S. dollar

Well, this sounds great, until you dig a little further …

In a move that could have dramatic consequences for global economies, China said Thursday it will no longer peg its currency to the U.S. dollar but instead let it float in a tight band against a basket of foreign currencies.

The yuan currency has been strengthened, effective immediately, to a rate of 8.11 to the U.S. dollar – compared with the 8.28 it has been set at for more than a decade – and the new trading regime will begin Friday, the government said in an announcement on state television.

OK, is this real reform or is this smoke and mirrors? After 10 years of price fixing, they’ve moved the currency to be 2% stronger. Is that going to change anything? All those fixed price contracts for cotton underwear, plastic flashlights and (the real reason we’re interested) stamped metal parts are going to be 2% more expensive, starting tomorrow. Actually, since trade with China is often cash in advance, the actual effective price increase will be with the next shipment after Friday.

Bottom line: none of those contracts moved to China for a 2% price advantage, and likely none are moving back for 2%.

So what really happened here?

The 2% is a tiny fraction of even the most conservative estimates of where the currency would go if it were allowed to float. So it’s extremely unlikely that this is the “right” number which would be determined by open trading. They’ve just substituted another political number for the original one.

The yuan will now be allowed to trade in a tight 0.3 per cent band against a basket of foreign currencies, the government said. It didn’t say which currencies.

One fixed price was substituted for another, and then the currency will be allowed to trade according to some hidden formula. This is if anything even less transparent than the previous scheme, and no more defensible in a free market environment.

Was the currency problem a 2.3% problem? Not even close. Has this gone any significant distance towards fixing it? Again, not even close.

I think this is smoke and mirrors. This was a rear-guard action to allow the Chinese government to say it is doing something while in fact doing nothing of substance. This will stop the congressional move to sanction China in the WTO, or at least reset the clock on it while people evaluate exactly how much “nothing” this move is.

Stalling tactic. That’s my summary.

Perhaps the most important thing here is that they blinked at all. It’s hard to blink only once.

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