China’s yuan: overvalued or undervalued?

By Chris Isidore
24 May 2010

Could the Chinese yuan be overvalued?

Critics have long accused China of keeping its currency artificially low in order to boost exports, and have pressured Chinese leaders to break that hold and allow the yuan to appreciate. But some experts now believe the crisis in Europe could actually push a free-floating yuan lower.

Some experts have argued that the yuan is 20% to 40% lower against the dollar than where it should be. Critics argue a key reason why China is growing so much faster than other major economies is because its undervalued currency is giving an unfair edge to its exports.

A higher yuan would benefit the United States by raising the cost of Chinese exports, which could help U.S. businesses facing competition from Chinese plants. It could also boost U.S. exports to the growing Chinese market by making them less expensive.

Treasury Secretary Timothy Geithner is in China this week to press Chinese leadership to let its currency trade more freely. The last time Geithner visited China in early April, many believed a move by China to let the yuan trade higher was just around the corner.

But the Greek debt crisis has sparked a 9% slide in the euro versus the dollar in just the last six weeks. Because of its peg to the U.S. currency, the yuan has appreciated as much against the euro as the dollar has. That makes appreciation of the yuan seem less likely.

“I think it’s pretty clear that [Chinese leaders] are backing away from it,” said John Makin, a principal at Caxton Associates and an expert in international finance. “They’re very nervous about what’s happening in Europe.”

Makin questions the assumption that the yuan would float higher if allowed to trade more freely, given the turmoil in global financial and currency markets.

“If they let the yuan trade freely, a month from now it might be down rather than up. The world situation is changing pretty rapidly,” he said. “It’s no longer clear there’s an unambiguous case for the yuan to appreciate.”

Ashraf Laidi, chief market strategist for CMC Markets, said he believes the yuan is still probably 7% to 10% overvalued versus the dollar, but agreed that if it were freely traded, it would be difficult to predict which direction it would move.

“We don’t know how much speculative interest there would be in the yuan,” he said. “There might be some dynamics out there that would cause the yuan to go down, behaving like other high-yielding currencies, because people would be fleeing it.”

Because of the euro’s recent slide against the yuan, exports from China are more expensive there. And Europe is an even larger market for Chinese exports than the United States.

Chinese leaders are concerned about the weaker euro and the slowdown in consumer spending in Europe cutting demand for Chinese exports. And that drop in demand could in turn lower the value of the yuan if it were freely traded.

Laidi thinks the chances of the Chinese allowing the yuan to trade freely has dropped significantly since the last time Geithner was in China.

He said part of the reason is that European leaders are no longer making a coordinated push with American policymakers to pressure China to make a change. That has reduced pressure on China and “makes any U.S. request to China to revalue moot and not to be taken seriously,” he said.

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