Personal Wealth Management / Market Analysis

Show Me the Yuan

China will eventually have to free its capital markets and currency, but doing so gradually may be preferable to forcing the issue.

Story Highlights:


    Yesterday, we discussed Japan's recent actions to manipulate the yen. As we said, such efforts are usually ineffective in the long run. Yet it may have occurred to some readers (especially in light of Thursday's uptick in anti-manipulation sentiment in the press) that China's pegged its currency for years. How is that possible?

    Short answer: China willingly pays a price most developed countries won't. Japan, the US, and other developed countries generally allow free capital flows (and have for decades) to their great benefit, whereas the Chinese keep a short leash on capital markets. Countries are free to do as they wish to help bolster their economies, and, arguably, the Chinese strategy has paid off richly. But it's not the only game in town—Brazil and India are successful Emerging Markets without massive controls. And, ultimately, currency and capital controls are costly and unsustainable.

    Maybe Chinese currency manipulation creates an "unfair trade advantage" (as US politicians complain), but more important for global markets is whether China successfully retools its clunky financial system. China is just one manipulator in a vast sea of free global exchange, but sudden, steep exchange rate fluctuations or even greater financial distress would be concerning. Getting to a free-floating yuan may be a more complicated task than US politicians fathom (many of whom believe the yuan needs to be revalued at least 20% higher). Forcing change for the sake of change may not be wise, but that doesn't mean no change happens at all.

    Chinese officials seem to accept the country will have to free its capital markets and currency eventually and appear willing to move gradually in that direction. Earlier this year, China loosened its grip on the yuan. And while it may seem they're simply playing the political card, the move was more than likely for selfish reasons, too (not only to placate Chris Dodd). In combination with a freer yuan, easing of currency trading restrictions marks another tentative, but notable change this year.

    Gradual is a good outcome for global markets, and China's productivity-driven growth buys it the time to pull reform off. So, as China eases off capital controls, why force the issue—or worse, start a trade war if they don't perfectly comply with political demands from half a world away? In the long run, open trade with China will be plenty rewarding. And in the meantime, if the Chinese government wants to pay for discounted goods and services to the US, we might as well take that gift.

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    *The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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