The US Treasury officials are not happy about the recent depreciation of the Chinese renminbi after a period of appreciation from 2010. Chinese authorities want to avoid the influx of ‘hot money’ into the economy and therefore the central bank has been keen to trick speculators who are getting used to a steady appreciation. This can put doubt in the minds of foreign exchange dealers who can take the hint and sell renminbi which in turn depreciates the currency further. Nevertheless the depreciation of the renminbi is greater than you think once you consider inflation.
How do they set the renminbi exchange rate?
Each day at 9.15am Bejing time the Peoples Bank of China – the Central Bank – in conjunction with the State Administration for Foreign Exchange (SAFE) issues a circular to all the banks in China stating the reference rate for the US dollar against the renminbi. However authorities are now experimenting with allowing the renminbi to move within a daily limit either side of a benchmark set by the central bank.
How does inflation affect the value of the currency?
What has little exposure in the media is the impact of relative rates of inflation in different countries when working out if a currency has depreciated and appreciated. The depreciation of the renminbi is actually greater than what you think. Figures that are widely used to show the level of depreciation are stated in nominal terms and does not account for the difference levels of inflation in both countries – in this instance the US and China. When you consider the real value you find that between December 2013 to April 2014 the renminbi actually fell 3.2% rather than 2.8% – see table below. However if you consider the period June 2010 through to November 2013 the renminbi actually appreciated 18.5% in real terms as against 12% in nominal terms. Inflation makes a difference because if there is higher inflation in the US than in China in takes more renminbi to buy the same number of goods so the renminbi is worth less. The opposite applies if the inflation rate is higher in China.
The above is a brief extract from an article published in this month’s econoMAX – click below to subscribe to econoMAX the online magazine of Tutor2u. Each month there are 8 articles of around 600 words on current economic issues.