China's currency surged to a 19-year high against the greenback this week, prompting some to suggest the Asian economic giant is playing favourites in the upcoming U.S. election.
But other China watchers see the rising yuan as an attempt to boost the confidence of investors concerned about China's slowing economic growth.
The world's second-largest economy is expected to grow at less than 8 per cent in 2012 – far below the average double-digit gains enjoyed in recent years. Other than a stabilizing real-estate market, China's economic data has offered few solid reasons for bullish optimism and widespread fears of a "hard landing" for the Chinese economy persist.
So why the rise?
Some are pointing to the upcoming U.S. presidential election, and suggest the People's Bank of China (PBOC) is intervening to goose the currency, commonly known as the yuan, to help President Barack Obama's re-election efforts. Mr. Obama is regarded as less hawkish towards China while Republican candidate Mitt Romney has vowed, if elected, to brand the country as a currency manipulator.
Mr. Romney and others have charged that China keeps its currency artificially low by compiling foreign currency reserves including U.S. dollars. Critics say this helps China's massive manufacturing and export sectors and costs jobs in the West.
"Does it work in Obama's favour?" senior currency strategist Camilla Sutton of Bank of Nova Scotia told The Globe and Mail. "Absolutely."
The jump in the China's currency, which closed at 6.2673 yuan to each U.S. dollar on Friday, down from Thursday's close of 6.2770 yuan to each U.S. dollar, also comes as officials from the International Monetary Fund and the World Bank are meeting in Tokyo this week.
The PBOC sets a mid-point for yuan trading every day from which the currency can rise or fall by 1 per cent. The value of the yuan has often risen in the run-up to such meetings where global currency values are in focus.
Concerns about a slowing Chinese economy had pushed the yuan lower against the U.S. dollar for much of the year. By the end of July, the currency had retreated by 1.6 per cent. With the recent increases, the yuan has now appreciated about 0.4 per cent against the greenback this year. Some have pointed to the latest round of quantitative easing initiated by the U.S. Federal Reserve, which includes the buying of U.S. assets and treasuries, as a possible reason for the yuan's increase.
Na Liu, the president and founder of CNC Asset Management Ltd., believes there are other considerations at work, namely an attempt ratchet up investor faith in the Chinese economy.
"Besides political considerations and the QE effects, I think the PBOC also wishes to shore up investors' confidence. A stronger spot exchange rate for the yuan helps diminish the depreciation expectations for the Chinese currency and underpins investor confidence for the Chinese economy. And in turn, it reduces people's desire to hoard the U.S. dollars and makes people more willing to convert dollars into yuan. This mechanism helps increase the local money supply and boost domestic economic activities," Mr. Liu said in an interview.
The yuan's strong rise has not been mirrored in offshore forwards markets which are predicting a 2 per cent depreciation of the yuan over the next year.
While China's economic data has been gloomy, anecdotal evidence contradicts fears of a hard landing. During one night of China's "Golden Week" holiday in early October, for example, the National Holiday Tourism Office reported a 30.4 per cent increase in visits to tourism sites and a 36.6 per cent increase in revenues by these tourist destinations.
Mr. Liu, an expert on commodity markets and Chinese demand, explained that despite the pressures that a rising yuan puts on manufacturers and exporters, expectations of mild appreciation are necessary to maintain confidence in China's investment driven economy and that is why the PBOC is guiding the spot exchange rate higher.
"It makes sure foreign investors are interested in investing in the economy and it makes sure local investors want to keep money in the economy rather than converting it to foreign assets," Mr. Liu said.
"If you are a Chinese entrepreneur who has made a lot of money and believe the yuan is going to go higher you are going to keep the money in China rather than converting yuan into U.S. dollars and buying a home in Los Angeles," he added.
The deputy governor of China's central bank said the value of the yuan is near its equilibrium level and that the PBOC has "dramatically reduced" its intervention in currency markets.
Reuters reported that Yi Gang, in remarks made in Tokyo at the IMF meetings, argued that the value of the yuan is now being dictated by market demand and supply.
"People might not know that the People's Bank of China has dramatically reduced the intervention in the market place. For more than one year, the official reserves of China have been flat," Mr. Yi said.