Free the Yuan (and Katie too!)

It finally happened: The Yuan is free!

Well, not entirely free. But more free, nonetheless.

The Chinese government officially ditched its peg to the U.S. dollar. It’s not a big move. The yuan is only 2.1% higher against the dollar.

The Chinese central bank will now keep to a tight 0.3% band against a basket of currencies. They won’t say what those currencies are, but I assume it includes the dollar, yen and euro, plus a smattering of other Asian currencies.

Even though the timing was a surprise, this move is hardly big news. I’d have to agree with one analyst who said that this reform is the tiniest thing China could have done. But it does give the Bank of China more flexibility in the future.

The problem with currency pegs is that they’re simply price-fixing, and price-fixing screws up the normal ebb and flow of capital markets. If you wait long enough, you’ll start to see weird side effects.

For example, Americans have been gobbling up goods made in China. If it were a country, Wal-Mart would be China’s eighth-largest trading partner. I also think that a lot of the huge demand we’ve seen for things like steel is a consequence of yuan. Also, the Baltic Dry Index, which is a barometer of shipping costs, plunged today to it lowest level in two years. This could be a freefall.

What happens next is a big mystery. Right now, gold is up and bonds are down. I suspect that long-term bond yields will continue to rise, perhaps to 5%.

Posted by on July 21st, 2005 at 1:05 pm


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