US Spends Its Way to Chinese Solution

For years America has warned, lectured and cajoled the Chinese to allow the yuan to rise in a bid to end the fiscal imbalances that have seen more and more US debt sit in the People’s Bank of China's vaults.

Nanjing street shopping district.
Grant Faint | The Image Bank | Getty Images
Nanjing street shopping district.

The Chinese clearly do not like being told what to do, so after years of failure on the yuan it appears the US has finally found a way to get the result it wants – spend, spend and spend some more.

“China’s stance on currency policy is visibly changing as officials have come to realize that, unless they make some significant changes, the nation is condemned to lending vast amounts of new money every year to nations or regions that they have a fundamental mistrust of at a fiscal level,” said Simon Derrick, the head of currency research at Bank of New York Mellon in a research note.

With the current Chinese five-year plan indicating a move towards currency liberalization by Beijing, Derrick predicts that by 2016, markets could see the promised land of a near free float.

While full currency liberalization may well be the ultimate goal, "there will, of course, be a significant number of interim steps along the way,” Derrick said.

“Indeed, officials have stressed time and time again over the past few months that the pace of reform will be gradual,” he added.

Pointing to a long line of comments from Chinese officials, Derrick believes the pace of change on the yuan will quicken over the coming years.

“There was certainly plenty of evidence that China was now allowing its currency to take on an increasing role in the battle against inflationary pressures during April as USD/CNY was allowed to fall a healthy 0.9 percent,” he wrote.

While this has eased in May, Derrick believes this is more to do with dollar strength that a change in policy from China and is predicting the next change in policy could be coming soon.

“In light of this, it might be worth keeping a close eye on events over the next few weekends,” said Derrick.