Having opined extensively on this topic previously, I will attempt to be brief. My general feeling has always been that appreciation is inevitable, and calls for it were somewhat self-serving and probably detrimental. Regardless, the scale of ensuing changes will of course depend on how fast appreciation occurs. Maoxian projects that the Rmb could reach 5 to the dollar by 2020, which seems a bit conservative, given that 2007-2009 were rather unique in terms of market performance. Though there’s no explicit relationship between equities and currency trades, it seems evident that policy makers use major indices as barometers, and no properly Confucian party apparatchik wants to be behind a yuan revaluation if exports collapse and riots start.

Recent inflation figures probably gave pro-appreciation groups (Ministry of Finance, PBoC) the cover they needed to push this through. I’m less convinced that the move was blatant a nod to G20 as some other commentators believe, though timing was still an issue. Properly Confucian party apparatchiks absolutely do not want to be seen as heeding foreign demands, and the last several weeks have been the only time period in recent memory where there hasn’t been a high-profile meeting with some barbarian global dignitary calling for a yuan revaluation. After the G20 meeting would have been unthinkable,

There’s obviously a a large amount of concern that short-term inflows will rush into China, so much so that authorities will in all likelihood depreciate in order to send a signal. After that, volatility and an upward (downward?) trend to a stronger Rmb.

The amount of attention that’s gone towards Rmb revaluation in the last several days seems out of place, if only because gradual appreciation of the currency appears obvious and inevitable given that numerous agencies and bureaus are putting in place machinery to deal with its impacts, such as SAFE diversifying away from USD exposure as much as possible or Shanghai and Shenzhen stock exchanges moving towards international Rmb denominated listings, which will eventually require free(er) capital flows.

Rmb appreciation will not materially affect the U.S. trade deficit, and it will have questionable near-term impacts on imbalances. As Chinese gain more purchasing power, they will likely do things like leave the lights on after 5:00pm (and consume more coal and oil as a result), pushing up energy prices. Americans will then (broadly) be forced to pay more to drive their hummers and power their plasma televisions, increasing the United States’ total import bill. Furthermore, there will likely be some level of input-import substitution occurring within China itself, if mainland manufacturers find that they can suddenly purchase other components more cheaply. Threatening sanctions to hasten this process – for dubious gain – is nationalist stupidity at its most pure.

For what’s at stake among various interest groups within China, we turn to the eminent Professor Pettis:

A revaluation shifts wealth from the Chinese government and the manufacturing sectors (and some wealthy Chinese) to Chinese households — which, by the way, is pretty much what is meant by “rebalancing” in the Chinese context. There are many other ways besides revaluation to shift income this way. The PBoC can raise deposit rates, wages can rise faster than productivity, companies can be privatized by giving away shares to the pubic, and so on. They all have the same effect. They shift resources to households and away from producers, infrastructure investment, and real estate developers. This allows household income to grow relative to national income, which ultimately increases the consumption share of GDP.

Domestic Chinese exporters don’t have a leg to stand on for a weak Rmb peg, at present. That doesn’t mean they aren’t lobbying for it, though. To the extent they will be able to sell an us vs. them narrative, anti-China sanctions will only provide more ammunition to make the case for more domestic subsidies, be they explicit (tax breaks) or implicit (currency).

When the crawling exchange rate revaluation was introduced in 2005, Chinese exporters claimed that it would ruin their competitiveness and lead to mass unemployment (and eventually a repeat of the Wuchang uprising, down with the man!) Instead of insurrection, total Chinese exports continued to increase during the period of the crawling peg. This graph shows the inverse of US-China trade deficit (effectively, Chinese net exports to the US) and the USD-CNY exchange rate (Chinese net exports to US, left axis, USD million; exchange rate on right axis):

Despite a rising currency and financial crisis, the Chinese trade surplus continued to increase throughout the last several years. This means that major exporters, who claimed that a stronger currency would harm sales to their primary market (the US), don’t have much of a foundation to stand on.

The Rmb will be revalued (likely another crawling peg); probably sometime in the next eighteen months. The central government has committed to a number of policy goals (decreased reliance on international demand, an increase in domestic purchasing power), both of which would be served by a stronger Rmb. Since exporters will be the major group opposed to a currency revaluation, the fact that there’s not a shred of evidence that they were harmed by the events of the past three years stands as a strong indictment of their case.

Hmmm – August TIC data indicates only a small increase of foreign held treasuries. They are being bought by domestic savers, or the increase in outstanding payments just didn’t go up by that much? On the subject of currency dynamics, Feldstein in the FT (“Why the renminbi has to rise to address global imbalances”):

The dollar must decline relative to other currencies to make US products more attractive to foreign buyers and to cause Americans to substitute US goods and services for imports. Without that incentive to increase exports and reduce imports, the rise in domestic spending will just lead to US economic weakness and rising unemployment. That is why the recent decline in the dollar relative to the euro, the yen and other currencies is a natural and desirable part of the process of reducing the US trade deficit and shrinking global imbalances.

… China’s policy of expanding domestic spending while depressing the renminbi will lead to its economy overheating, particularly its manufacturing sector. Allowing the renminbi to rise would shift demand in China from manufacturing to services and prevent inflation. A stronger renminbi would thus reduce China’s domestic imbalance and global imbalances.

And slightly related, a good read by Megan McArdle about why hyperinflation isn’t a serious worry:

I think the much bigger worry is that we are going to drive ourselves into a corner where the bond markets will force us to slash benefits to people who have planned their lives around them, making those people worse off than they would have been if the program had never existed. And also, of course, that they will raise taxes by enough to produce serious, painful deadweight loss. But until Ben Bernanke starts looking much more inflation-friendly than I’ve so far seen, any kind of effort to totally inflate away our national debt is pretty low on my list of potential problems.

On the subject of sovereign debt, though, I suspect Japan will become more important in coming years:

Tokyo has let the yen appreciate violently – 90 to the dollar, 13 to the Chinese yuan – giving another twist to the deflation knife. Top exporters are below break-even cost, says RBS. The government could stop this, as it did in a wave of manic dollar purchases from 2003-2004. It could print money à l’outrance to stave off deflation. Yet it sits frozen, like a rabbit in the headlamps.

Japan’s terrible errors are by now well known. It failed to jettison its mercantilist export model in time. It resisted the feminist revolution, leading to a baby strike by young women. It acquiesced in a mad investment bubble (like China now) in the 1980s, stealing growth from the future.