This is a compelling story, but probably a misguided one. To see why, ask yourself the question: Where do those billions in reserves come from every month? Over the past year, roughly half of China's [foreign exchange] reserve inflows came from portfolio capital, including so-called hot money flows. In effect, Chinese banks and firms have been drawing down their asset positions abroad, or borrowing money in foreign markets, and bringing these funds back to the mainland, in part to speculate on a possible renminbi move.It seems, of late, that the common wisdom, more and more often, turns out to be wrong. The common wisdom before the Canadian election said that the Canadian people would remove the Liberal government from power, possibly giving the Conservative Party a minority government - it was all over the newspapers, at any rate. Reality: the Liberals retain a minority government, one seat away from a majority. The common wisdom before the American election said that John Kerry and the Democrats would win walking away - even the exit polls early on November 2nd demonstrated this trend. Reality: GWB wins with the largest number of votes in American history, the first true majority in 16 years, and the Republicans expanded their lead in both houses of Congress. The common wisdom before the Iraq invasion was that Saddam has storehouses of hidden WMDs, and that once the US had deposed him, the oil-rich nation would unleash its flow of gasoline into the tanks of American vehicles, driving the gas prices down to record lows. Reality: Saddam's weapons storehouses were empty, at least of nuclear and biochemical missiles ready-to-launch (where the weapons went is a question for the UN inspectors), and the price of gasoline has remained at record highs.
But this means that as private agents move out of dollars and into yuan, the PBoC is buying up the dollars and pumping them right back into the U.S. The net effect on U.S. markets from these transactions is...virtually zero! [ellipsis in original] This is an overly simplified explanation, but very close to the mark nonetheless. Despite the apparent size of the headline reserve accumulation, China's true support for the dollar is much smaller.
The bottom line? It's surprisingly difficult to argue that the Chinese renminbi exchange rate--or the exchange regime--has had any substantial impact on the way the rest of the world works. Whether we look at jobs, trading patterns or global currency markets, China still shows up as a relatively small economy, and certainly not one that is "driving the show," now or in the near future. And whether the peg stays or goes is a sublimely unimportant issue in the large scheme of things.
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