June 17, 2008 | posted by Michael Baxter in China, inflation |

It is a funny thing, but US politicians have been screaming for China to let the Chinese currency appreciate against the dollar.  Sometimes it is as if they seem to think the cheap yuan is the source of all their troubles: a rising yuan the only true way to put an end to the credit crunch.

But actually there were good reasons to think a rising yuan would not be quite the panacea we were told it would be.  Well, now we are set to find out.   

The yuan has been steadily rising for three years.  Back in 2005 the Chinese government sort of ended the peg with the dollar.  We say sort of, because the government still leant heavily on its currency, just not as heavily as before, and only allowed a gradual appreciation.

So in effect, the Chinese government relaxed its policy of buying dollars to maintain a cheap currency.  

The Chinese policy of maintaining a cheap yuan had led to the export of Chinese cash to the US, as she bought dollars.  This in turn was one of the key factors that created the noughties credit boom.

The change was gradual, but just like the tiny movements of tectonic plates, over time the change can be dramatic indeed.    It was the movements of tectonic plates that saw the land mass of India gradually colliding with the land mass of Asia which created the Himalayas.  The gradual rise in the value of the yuan is in economic terms almost as dramatic.

Before the peg was lifted there were 8.2765 yuan to the dollar.  This morning it was 6.898; that’s a 20 per cent movement.

So what are the implications of this change?

Well for one thing it has meant less dollars being bought by the Chinese, which has meant less money flooding into the US – which must surely have been a factor in the drying up of credit last year and this.

For another thing, a more expensive yuan has meant more expensive goods from China, and from China’s point of view, foreign goods are looking cheaper.

So a slowly appreciating yuan should help relieve inflationary pressure in China and push up prices in the West.

It should also enable the US to enjoy higher exports to China while imports fall.

We are nowhere near the end of the saga.   As Churchill once said, it is more like “the end of the beginning.”  It seems likely the yuan will rise much higher yet.

But whether this is the true tonic we need in the West is another matter altogether. 

From China’s point of view, a rising yuan will be good for its inflation rate.  Remember Nigel Lawson trying to maintain parity with the Deutschmark in order to keep inflation in check, during the late 1980s.

But, remember this, it was cheap imports from China that helped create low inflation for much of this decade.  The rising yuan means these prices will rise, just at a time we are fretting about inflation.