The People’s Bank of China announced yesterday the release of its currency from the chains of its former peg. Or, to be precise, the yuan will ebb and flow as defined by a managed float administered by its central bank master. Think of it as a cross between a peg and a true float: a little of each and something less than either.

Whatever label applies, the news was something less than, well, news other than the timing. Expectations have been widespread that China would soon allow the forces of supply and demand a greater say in valuing its currency. Indeed, Treasury Secretary John Snow has been pushing for no less for some two years, and financial journalists have been writing about it for just as long.
The fact that the news of the yuan float came yesterday as opposed to last week or next month captured the attention of the business pages around the world. And rightly so, as the ramifications for the long term are at once complex and enormous. That’s to be expected, given the size of China’s economy and its growing integration with the world economy. But if anyone was truly shocked, shocked to learn that the yuan had shed its peg shackles just hasn’t been paying attention.
Among the markets that have arguably suffered from attention deficit disorder regarding the yuan is the bond market here in the U.S. Yesterday, the benchmark 10-year Treasury Note’s yield jumped by 12 basis points to a close of 4.28%, the highest since early May in the wake of the Chinese currency news. If there’s any criticism due fixed-income traders, one could argue that the market should have been elevating long yields all along in anticipation of higher prices tied to Chinese goods. “In theory, a stronger Chinese currency should raise import prices,” Jay Bryson, global economist at Wachovia Corp., tells USA Today.
Another dismal scientist reminds that “over the past 10 years, Wal-Mart has been able to take prices down, putting pressure everywhere” by producing or buying 85% of its products in China, observes John Bott, chief economist of Tri-Star Financial, a Houston broker/dealer, in yesterday’s Houston Chronicle. But if the yuan rises against the dollar, as it did on its first day of float, higher prices for dollar-based buyers of Chinese goods are a forgone conclusion. In that case, “we will import that inflation” born of a stronger yuan, Bott says of America’s to-date rising appetite for items exported from the world’s fastest-growing large economy.
There’s also a fear that a strong Chinese currency will add one more reason for oil’s price to rise. As Bloomberg News today reported, “Crude oil gained for the first day in three on speculation China’s refiners will boost imports and increase output of fuels after the country yesterday let its currency rise against the dollar for the first time in a decade.” The story also quotes analyst, Jonathan Copus of Investec Securities in London, saying that oil demand in China could increase because “in the near term, it increases the purchasing power for crude and other commodities.”
To be sure, the government-approved 2% move that defined the first day of the yuan’s new era of managed float isn’t likely to have much impact on the TV sets and Barbies that routinely arrive on America’s shore from the Middle Kingdom’s factories. But almost no one thinks a 2% change is the end of the yuan’s flirtation with market pricing; rather, it’s only the beginning, and where it ends is anyone’s guess.
The extent of higher prices depends on how much the yuan rises, and the options available for importing from less costly sources or, say a few optimists, producing more stuff on the home front. But if there’s a chance that all will work out well for the U.S. economy, Euro Pacific Capital’s president, Peter Schiff, doesn’t see it. “China’s decision to change the nature of its currency peg means that it will no longer be in the dollar buying business, or by extension, the U.S. Treasury buying business,” he writes in a commentary posted on the firm’s web site. The implications, as Schiff see them, are as follows:
1. Higher consumer prices.
2. Higher interest rates.
3. Reduced profits for American companies, particularly those dependent on domestic consumption and consumer debt.
4. Lower stock prices, as earnings decline and multiples contract.
5. The busting of the housing bubble, as tighter credit standards and higher interest rates squeeze current home prices.
6. Rising unemployment, as higher interest rates and vanishing home equity slow consumer spending and reduce jobs dependant on that spending.
7. A severe recession as a result of all of the above.
8. Rising federal budget deficits, as recession reduces tax revenue, while higher interest rates and escalating outlays increase expenditures.
Schiff, a long-time pessimist on the dollar’s future, finds the yuan’s new status in forex as one more reason to stay bearish on the buck. But if the dollar’s headed for rougher waters, it wasn’t obvious today. The dollar rallied smartly today, as per the U.S. Dollar Index. Meanwhile, gold retreated a bit in sympathy. Even the 10-year Treasury reassessed its first reaction to the yuan news, with the yield on the benchmark bond pulling back in today’s session.
All of which suggests that if an economic Armageddon triggered by the Chinese currency is coming, it’ll have to wait till Monday. Enjoy the weekend.