China’s tightrope walk

The People’s Bank of China had a busy weekend. 

In response to the warning shot fired by this blog pressure from the G-20, the PBoC issued a statement on Saturday:

In view of the recent economic situation and financial market developments at home and abroad, and the balance of payments (BOP) situation in China, the People´s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility….

The global economy is gradually recovering. The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability. It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility.

In further proceeding with reform of the RMB exchange rate regime, continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market.

This is central bankese for, "yes, we’re going to allow the RMB to float, get off our backs now." 

This sounds great, except that 24 hours later the PboC issued a second, Chinese-only statement, according to the New York Times’ Keith Bradsher:   

The central bank, the People’s Bank of China, said on Sunday that it was determined to “keep the renminbi exchange rate at a reasonable and balanced level of basic stability.”….

The issue has become a tricky one internally for the Chinese government. While China still muzzles its media through censorship, public opinion expressed on the Internet has become an increasingly influential force.

Even though some Chinese economists and most Western economists say that a stronger renminbi is clearly in China’s best economic interests — because it would help China fight inflation by making imports cheaper — many Chinese see the issue mainly in terms of a rivalry with the United States…..

The central bank’s statement on Sunday was issued only in Chinese and was clearly intended for domestic consumption. In contrast, its announcement on Saturday was issued almost simultaneously in Chinese and English.

Today, the PBoC also left the midpoint trading for the RMB unchanged, indicating that there would be no initial appreciation of the currency, unlike what transpired in 2005.  That said, the RMB appreciated by 0.42% today, its largest appreciaton in five years. 

The PBoC also released an English-language Q&A that elaborates its thinking.  This part is intriguing: 

As its economy becomes more opened, China´s major trading partners now include a long and diversified list. During the period of January-May this year, trading volume with top 5 trading partners (EU, the U.S., ASEAN, Japan and China´s Hong Kong SAR) accounted for 16.3 percent, 12.9 percent, 10.1 percent, 9.4 percent and 7.5 percent respectively in China´s total trade. Meanwhile, capital and financial account transactions have also diversified across various regions in the world. RMB´s floating with reference to any single currency can neither meet the diversified demand currencies in trade and investment with different partners, nor reflect its effective level. A basket of currencies can meet such demand and reflect the effective RMB level more accurately. Therefore, it is necessary for the managed floating exchange rate regime to be based on market supply and demand with reference to a basket of currencies, and thus make the RMB exchange rate more adaptive to market behaviors.  As China´s trading and investment partners become more and more diversified, it would be more appropriate for enterprises and households in China to switch their attention from just RMB-to-dollar exchange rate to the RMB´s value in terms of a basket of currencies.

So, has anything of significance happened? 

The Economist is doubtful.  The FT editorial team — and Geoff Dyer in particular — think the Chinese are being politically deft.  I have to concur.  China’s aim is to do just enough to placate the G-20 without enraging its domestic producers and online nationalists.  By switching to a basket — one in which the euro seems headed downward — China has greater flexibility to do whatever the hell it wants with respect to the exchange rate. 

Going forward, I’m curious about the extent to which Chinese authorities will play up their domestic constraints.  It’s very chic to point out the ways in which China’s government does have to deal with nationalist pressures — but the government also has an incentive to play those up as part of a two-level game.  One of the great unknowns is the extent to which Beijing can turn that nationalist sentiment up and down like a volume control.  I don’t know the answer, and I’m not convinced that China-watchers know either.

Developing…..