Sieren's China: Floating freely

Last Friday (December 12), the People's Bank of China (PBoD) announced that it would base the yuan's exchange rate on other currencies more than before. For the first time, China's central bank published the composition of the currency basket that the yuan will be based upon.

The US dollar is still playing a central role, but this is set to change in future. The yuan has been pegged to the dollar for the past 20 years and because of the greenback's current strength, the yuan has strengthened with regard to the currencies of China's most important trading partners.

A departure from dollar peg

This is set to end. The US dollar is almost on par with the euro now, but at the beginning of the year, the exchange rate was 1 euro to 1.25 dollars. This is why the Chinese central bank allowed market forces to depreciate the yuan to its weakest rate in a good four years. Beijing wanted to signal that it is no longer willing the yuan to get overvalued if the US currency continues to appreciate in the coming year.

In August, during the time of turbulence on China's stock markets, the PBoC had the world shaking when it allowed fluctuations of up to two percent either way in the yuan's daily exchange rate with the dollar. Now, the fixing of the exchange rate has become more transparent. While politicians in the US, in Europe and Japan are taking more liberties with their currencies, Chinese politicians are becoming less involved. This is just a phase, though: Western currencies and the Japanese yen remain much freer than the yuan. Nonetheless, China has received praise from the International Monetary Fund (IMF) for its steps.

Next fall, the yuan will be admitted into the IMF's currency basket. With currencies weighted in a particular way, the basket acts like an artificial currency and forms the basis for the IMF's international aid. Beijing's move is not about pleasing the IMF, however, nor about meeting its demands. It makes sense for the Chinese currency to be less pegged to the dollar. For the exporting nation that is China, the yuan is too expensive compared to the euro and the yen.

Cheap money against the crisis

Exports fell in November for the fifth month in a row and were down 6.8 percent over the previous month. Demand is also falling because Chinese products are too expensive because of the yuan. Only when the yuan is freed from the dollar will it become stronger once again. The Chinese central bank's reduction of interest rates is also a step in the right direction: At the end of October, the bank lowered interest rates for the 16th time since 2014. The current rate is 4.35 percent.

Like the West, China is trying to solve its crisis with cheap money. However, there is one important difference: As opposed to in Europe and the US, whose interest rates have been close to zero for years, China still has plenty of leeway. This is only going to get bigger when China has an exchange rate that makes more sense, and there is less pressure to devalue the yuan. In comparison to the same month the year before, industrial production in November increased surprisingly by 6.2 percent. Consumption rose to 11.2 percent and was higher than ever this year. The times are ideal for the yuan - it can float freely without fear of drowning.

Frank Sieren has lived in Beijing for over 20 years.