The Chinese government’s announcement that the yuan will be allowed to trade within a wider band starting this week is a major step toward creating a more modern Chinese economy.
China has been signalling for years that it is gradually moving toward a more open and normal economy, which includes moves allowing the yuan to float freely in the market just like other major currencies. But it’s been a program of baby steps. In 2005, China allowed the yuan to begin trading in currency markets, initially permitting a maximum swing in value of just 0.3 per cent daily. The daily trading band was widened to 0.5 per cent in 2007 and 1 per cent last year. And as of Monday, the daily limit is now 2 per cent.
The latest increase in the trading band is the most significant yet. With 2 per cent worth of daily leeway, the yuan will rarely bump up against its trading limits, given historical levels of volatility, which means the currency should largely trade as the market demands. No one expects the People’s Bank of China to take an entirely hands-off approach, but its range of policy options to manipulate the currency diminishes with each expansion of the trading band.
The yuan fell this week following the announcement, because traders fear that the Chinese economy is slowing. But in the longer run, the currency is likely to gradually rise as China’s economy grows and markets fully value the yuan. That’s what China’s trading partners want; they see the Chinese economy as overly dependent on exports. Chinese consumers with higher-valued yuan in their pockets will have higher living standards, will spend more, and will be able to afford to buy more goods from abroad, at higher prices – which will lead to higher living standards in China’s trading partners, including Canada.
Chinese leaders have previously indicated that currency reform is just one step in a process of modernizing the economy. The government announced a 60-point plan late last year that includes market reforms such as allowing private investors to set up banks and loosening rules for initial public offerings. The decision to widen the trading band to 2 per cent is a concrete sign that China is maturing as a global economic giant, which bodes well for the international economy. There remain reasons to condemn China’s human-rights record and lack of democracy, but the more the nation moves toward an open economy, the more Chinese citizens and the world economy as a whole will benefit. A wealthier China can make the world a wealthier place.