Smoot-Hawley Ver 2.0?

Reuters reports that the US Senate is expected to vote on a bill to punish China for its weak currency. Patrick Chonavec reports that there are now devaluation pressures on the RMB:

In recent days, however, something else has happened that potentially has far more serious implications. For the past decade, China has run surpluses on both its current and capital account. When it comes to both trade and investment, China is a net importer of foreign currency, which places pressure on its own currency to appreciate in order to resolve the imbalance. China has prevented the RMB from appreciating more rapidly than it desires by fixing a price at which it buys dollars (and other foreign currency) and stockpiles them as official reserves. Because that price has always been fixed below the market equilibrium point (the RMB has been kept undervalued), whatever limited trading band was set, the RMB tended to bump up against the upper limit. In other words, the RMB was a one-way bet, always under pressure to appreciate against the dollar.

Until this week, that is, when it started to bump up against the bottom of the trading band, implying that the RMB wanted to depreciate against the dollar. Why? Presumably because the capital account had flipped, and speculators were now rushing to turn their RMB into dollars in order to take their money out of China. It’s important to clarify what this does and does not mean. It does not mean that the RMB is now suddenly going to collapse in value. China holds US$3 trillion in currency reserves, and can deploy those reserves to support any exchange rate it wishes. Even if China were tempted to devalue (at the cost, it should be noted, of fanning inflation), the mounting political pressure in the U.S. Senate to take action against China for its undervalued currency would pose an obstacle to pursuing that path.

Rock, meet the hard place. The RMB is under pressure because of concerns about a hard landing in China. US policymakers need to be aware of market forces. Otherwise, they risk the path of Smoot-Hawley, which served to exacerbate the downturn during the Great Depression.



Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

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