Tags: Yuan | china | US | Dollar

Yuan's Wider Band Will Tighten Noose Around US Dollar

Wednesday, 18 Apr 2012 08:39 AM

By Ashish Advani

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We have been debating the demise of the U.S. dollar as the reserve currency of the world. I have written about it a few times myself. What happened over the weekend and the pattern observed in the past two trading days compels me to write about it again.

Over the weekend, the People’s Bank of China (PBOC) announced that it was increasing the band in which the yuan will trade. The yuan, or renminbi, had been pegged to the U.S. dollar at 8.28 for a very long time.

Back in 2005, under tremendous pressure from the world, Chinese officials broke the peg and the value of the currency became an opaque basket. No one knows what the basket of currencies consist of.

The yuan has increased in value by 8.3 percent since it started revaluing against the U.S. dollar. It has been a painstakingly slow rise. What isn't obvious with the 8.3 percent increase is the other rapid moves the yuan has made in globally to gain acceptance.

So when the peg was broken back in 2005, the PBOC had agreed that they would fix the value of the yuan for the day and it could swing in a 0.5 percent move on either side. This weekend, they increased the band to 1.0 percent on the upper and lower end of their fixing.

This means that the PBOC is setting the stage to be able to respond to the market gyrations in a wider manner than before. While they increase their tools to manage the yuan better, the fear I had was that this will lead to a higher flow of hot money chasing appreciation. Interestingly, the exact opposite happened.

The yuan has declined since and has actually acted in accordance to the economic factors in play. The decline in trade surplus, the slower than expected GDP growth should have led to the currency decline — and that is exactly what has happened. Now that is a sign of a maturing currency.

What is also fascinating is that the one-year projections of the yuan is actually showing a slight decline instead of a higher trend, which could be a sign of speculation at the longer end of the curve.

Once again we are seeing signs of complete normalcy of the yuan despite the widening to the trading band.

The widening of the yuan band is one more small cut in the fortunes of the U.S. dollar.

I would recommend that you invest a small portion of your investable capital in the yuan. There are U.S. banks which are FDIC insured where you can buy the yuan and enjoy the gains from the safety of your home.

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