Is China Stopping Control Over the Yuan?

Is China Stopping Control Over the Yuan?
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Don't look now, but China may be stepping away from its practice of controlling the level of the yuan.

China's currency policies may be a hot topic for Governor Mitt Romney in the Presidential election, but beneath the surface, all the bluster may be for naught.

That's the takeaway from a new analysis by Simon Derrick, chief currency strategist at Bank of New York Mellon.

Derrick notes that China's reserve growth has essentially stalled.

"Between September of last year and September of this year China's FX reserves grew by just 2.75 percent" he wrote in a note to clients. "In contrast, the average year-on-year growth rate since 2001 has been a little over 30 percent while the lowest numbers prior to this year were 11.7% in December 2011 and 12.1 percent way back in March 2001. Given how important the process of reserve diversification has proved over the past decade for the broader currency markets, we need to ask whether we are seeing a fundamental shift in the underlying pattern of reserve growth."

But what does reserve growth have to do with China's practice of controlling the level of the yuan? Plenty, Derrick says. He has parsed recent statements from central bank and government officials there and concluded that "the authorities are becoming increasingly comfortable with allowing the currency to find its own level."

That's important for several of the world's largest currencies, Derrick says.

"If we are getting to the point where FX reserve growth in China (and subsequently elsewhere) starts to become a thing of the past then this will have significant long term implications for those currencies (and their underlying asset markets) that have been supported over time by the process of diversification." In other words, if China is no longer putting downward pressure on the yuan by buying other currencies, a key support for those currencies is being withdrawn.

Stay tuned.



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