China's New Currency Basket

China's New Currency Basket

July 21, 2005

Today, China announced they would switch from pegging fixing their currency against the dollar at 8.3 yuan = $1. They will now peg the yuan against a basket of currencies, with a new rate announced each day. The basket will reflect China’s trading partners.

Thought you would like to see what that basket might look like. The chart below shows the shares of China trade (imports plus exports) with major currency regions.

China's Top Trading Partners

As you can sese, the US accounts for only 14.8% of China’s trade. We are tied with Japan (14.8%), but behind Europe (15.5%) and the countries of the Pacific rim excluding Japan (34.9%). the latter include Hong Kong, Singapore, Taiwan, Mayalsia, Indonesia, Australia, New Zealand, Thailand, Phillipines, and the smaller members of ASEAN. The final 20% is “Other”, which includes Russia, Canada, Mexico, Venezuela and others.

So, a rough guess about the new Chinese basket would be to match the composition of the basket to the pie chart. But many of the countries in the Pacific and Other slices peg to the dollar too, so the role of the dollar could be somewhat larger than it would at first seem.

If the Chinese central bank decides to hold only US dollar, Euro, and yen assets, spreading the remaining slices proportionally across the three major currencies, they would hold 33% dollars, 34% Euros,and 33% yen. If they choose to use the dollar to represent the Pacific and opther categories they would hold 70% dollars, 15% Euros and 15% yen. These numbers could also be affected by growth considerations (EU trade is growing fast), and investment considerations (big US capital flows in technology and telecom equipment) which wold skew the basket towards the dollar. they could also carve out a separate slice for the Pound.

However they slice the pie, however, there will be less dollars in it that today. This means smaller Treasury purchases and higher interest rates in the US.

Translation: If you line in America, your wealth just went down.

More to come on stock markets.

JR

John Rutledge

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