There’s a currency union that’s driven the world economy for the past 25 years. It’s not the euro, important as that is. No, I’m referring to the connection between China and the US. Our two economies account for over a third of all global production – and trade between us is increasingly important.
For more than 20 years, China has kept its currency tied to the dollar—appreciating the yuan modestly since 2000. Financial markets have come to expect little short-term volatility. By connecting their currency to ours, they effectively import our monetary policy. When the dollar rises against the yen and euro, so does the renminbi. In the past, China has been able to offset the effects of Fed policy by varying its large level of public investment. But China’s currency moves over the past several months suggest this may be about to change.
USD/CNY Spot Rate. Source: Bloomberg
This could have a big effect. US/China trade amounted to almost $4 trillion last year. If a Chinese importer owes a lot of dollars to a lender, a big shift in the exchange rate could cause the loan to go bad, hurting the borrower, lender, and trade between our two countries. With so much at stake, policy makers on both sizes of the Pacific Ocean need to recognize how important this currency regime is and move clearly and deliberately towards any alteration.
The alternative: a sudden, unanticipated change, followed by economic disruption and market chaos, would not serve anyone very well.
Douglas R. Tengdin, CFA
Chief Investment Officer