The Currency Play – Act 1, Scene I
Don’t let anybody tell you that they know what the Chinese government will do with the yuan because they don’t. If you are interested in the pros and cons of yuan revaluation, some time ago Michael Pettis wrote a nice article worth revisiting. Basically, all signs economic point toward yuan appreciation.
The fact is, that nobody in the entire world, except for a handful of people of course, knows the plan for the yuan. Markets have become more and more convinced that the yuan will appreciate over the next year.
The chart above illustrates the implied currency rate for the value of the US dollar (USD) in Chinese yuan (CNY) one year from the date shown on the X-axis, as derived from the 1-yr ahead non-deliverable forward. For some time, markets have “thought” that the Chinese would let the yuan appreciate (a movement down the Y-axis is an appreciation of the yuan and a depreciation of the US dollar) against the US dollar.
But ex post, markets have no clue.
The chart above illustrates the implied currency rate for the value of the US dollar in Chinese yuan by the 1yr non-deliverable forward one year before the X-axis date in blue. The the current ex post spot rate one year later (the date on the X-axis) is in red.
Basically markets are just fine at predicting trends, i.e., the positive correlation between the spot and forward rate spanning 2006 and 2007. But the reality is, that markets have absolutely no idea how the Chinese will value the yuan in one year, as illustrated by the -0.47 correlation coefficient spanning the years 2008-current. In fact, markets were looking for further yuan depreciation one year ago, but guess what: the yuan hasn’t budged since 2008, roughly 6.83 CNY per USD.
Originally published at News N Economics and reproduced here with the author’s permission.