The beginning of the end of Bretton Woods 2?

China’s central bank posted the following announcement on its web site today:

1. Starting from July 21, 2005, China will reform the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. RMB will no longer be pegged to the US dollar and the RMB exchange rate regime will be improved with greater flexibility. 2. The People’s Bank of China will announce the closing price of a foreign currency such as the US dollar traded against the RMB in the inter-bank foreign exchange market after the closing of the market on each working day, and will make it the central parity for the trading against the RMB on the following working day. 3. The exchange rate of the US dollar against the RMB will be adjusted to 8.11 yuan per US dollar at the time of 19:00 hours of July 21, 2005. The foreign exchange designated banks may since adjust quotations of foreign currencies to their customers. 4. The daily trading price of the US dollar against the RMB in the inter-bank foreign exchange market will continue to be allowed to float within a band of 0.3 percent around the central parity published by the People’s Bank of China, while the trading prices of the non-US dollar currencies against the RMB will be allowed to move within a certain band announced by the People’s Bank of China.

What does this mean? In the short run, not much — China is effectively appreciating its currency by only two percent and widening its band a bit. More interesting will be whether this initial move puts pressure on China to either revalue more or let its band widen more in the future. The statement implies that the Central Bank could do this, but my hunch, and the press coverage of the announcement, leads me to believe they’ll sit on 8.11 for some time. In the medium run, the decision to move from a fixed exchange rate of a managed float is going roil the currency markets a bit — see this Bloomberg report on the yen, for example. More interestingly, Malaysia has followed China’s lead and has decided to move the ringgit from a strict dollar peg to a managed float as well. The really intriguing question is how much this move will retard public and private purchases of dollar-denominate assets. This Associated Press report suggests that other Asian central banks are taking this in stride. For the U.S., I’m not sure a two pecent revaluation is going to affect trade one way or the other. The rule of thumb has been that a ten percent revaluation would lower the trade deficit by one percent, so this won’t have that big of an effect on the trade balance (and I would wager that the J-curve effect with such a small revaluation will be longer-lasting). The bigger effect may be political, in that this could eases protectionist pressures in Congress. On the other hand, it could also convince yahoos like Senator Schumer that this is the way to pressure the Chinese into making foreign economic policy concessions. On the other hand, if Xu Haihui’s report for International Finance News — reprinted in the Financial Times — is true, then the effect on certain sectors of China’s economy could be significant:

[A]ccording to initial estimates, for each 1 per cent the renminbi rises, each sub-sector of the textile industry will see its profits from exports reduced, including a drop of 12 per cent in the cotton sector, 8 per cent in wool, and 13 per cent in garments. Smaller segments of the garment industry that depend more highly on exports will face even higher losses…. Professor Wang Kangmao, the honorary president and doctoral adviser of the East China University for Law and Politics, recently told reporters that if the renminbi were to appreciate by 3 per cent the textile industry could face export losses of up to 30 per cent mainly due to a lack of value-added products. Uncompetitive small-and-medium-sized companies would then likely face bankruptcy, causing possible job losses for several hundred thousand workers. Since most of the employees in the textile industry come from low or medium income families, the loss of jobs could possibly trigger even greater social problems.

Developing…. UPDATE: For nice backgrounders on the issue, see this Wall Street Journal report by Michael Phillips (the link should work for everyone), this Financial Times renminbi page, and this backgrounder on China’s slowing economy in the Economist. [What does the title of this post mean?–ed. Click here for what I mean by Bretton Woods 2, and here for a basic BBC backgrounder.] ANOTHER UPDATE: Brad Setser weighs in: “Too small in my view to have much of an economic impact, in any way. On trade flows. Or on capital flows. I would still bet on a further revaluation.” Nouriel Roubini and David Altig are debating the implications of the move on the Wall Street Journal’s Econoblog.