Thursday, July 21, 2005

Yuans and Senses

I am not an economist; in fact, I don't even play one on the web; so I won't pretend to understand the first thing about international finance or currency evaluation. What I do have is common sense, and a logical mind —— at least I hope so, as my livelihood depends on it. When I heard some people complaining on NPR that today China's adjustment of her currency, renminbi yuan, is too little, not the %40 they had hoped, I just couldn't help thinking that's total nonsense.

Suppose we lived in an alternate universe —— hey, this blog is not called Vacuum Fluctuation for nothing —— and the Chinese government decided, instead of raising the value of yuan by 2% as they actually did today, they'd increase it, in one shot, by 40%, just to make some Americans happy. The effect of that would be catastrophic, worse than the '97 Asian financial crisis. The major Asian economies would probably collapse. Since that region is a major growth engine for the world, the world economy would be heavily damaged as well.

But that may be too abstract. Let's take an example closer to home then. Suppose in another alternate universe, you walked into your local Wal-Mart and found everything had been marked up by 40%: the $10 curtain is now $14; that $200 electric scooter is now $280... And maybe just maybe, since the yuan is worth so much more now, the Chinese had bought up the world oil supply, and gas price is at $4 a gallon. How would you feel then?

Back to the universe we are living in. If we do want that 40% increase of yuan's value, it's totally within the framework set forth by the Chinese government today. The key is, it's going to take some time. According to the Wall Street Journal:

The yuan will now be allowed to trade in a tight 0.3% band against a basket of foreign currencies, the government said. It didn't say which currencies. It said the central bank would announce the yuan's closing price each day, and that rate would be the midpoint of the next day's trading band.
Let's make things simple, and assume everything is against the US dollar. And since so many people think yuan is vastly undervalued, assume they'd buy up as much yuan as possible, so yuan would always go up the maximum amount allowed by the Chinese government.

After first day's trading, yuan goes up against dollar for 0.15% —— the previous day's closing was set as the midpoint of the trading band, so it could only go up as much as 0.3%/2 = 0.15%. That's 1.0015 times yesterday's closing price.

Let's assume people and banks the world over never run out of steam buying up the vastly undervalued yuan, so it goes up 0.15% against the dollar every day. After a month (the currency exchange is open 24x7, right?), the yuan would increase

1.001530 = 1.046

that's a nice %4.6 increase right there. And after a year

1.0015365 = 1.728

Wow! After a short year, the yuan would increase its value by 72.8%! I think even the most die-hard protectionist would be satisfied. The question is, would your Wal-Mart shoppers?


Blogger Jane said...

I cannot imagine anybody in their right minds would prefer the yuan go up 40% overnight. Must be nuts.

2:18 PM  
Blogger Rong said...

I know, but that was what the guy said on NPR. He is a manufacturer of some kind of metal springs used in bathroom scales. I guess when your livelihood is on the line, you'd always hope for a miracle. Wishful thinking is never rational.

4:50 PM  

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