China’s Yuan Rises To Milestone High

In a seemingly desperate attempt to contain her homegrown bubble, China now resorts to the currency valve.

Reports the Bloomberg,

China’s yuan strengthened beyond 6.5 per dollar for the first time since 1993, supported by speculation the central bank will allow appreciation to help tame the fastest inflation in more than two years.

The currency’s seventh weekly gain, its longest winning streak since July 2008, may damp U.S. criticism of China’s exchange-rate policy before Vice Premier Wang Qishan heads to Washington next month for talks with Treasury Secretary Tim Geithner. Consumer prices in Asia’s biggest economy rose 5.4 percent from a year earlier in March, exceeding the government’s 4 percent goal for this year.

“Inflation is still higher than what the government would like to see,” said David Cohen, a Singapore-based economist at Action Economics, who previously worked for the Federal Reserve. “The central bank is tolerating faster currency appreciation to contain import costs.”...

The People’s Bank of China set the yuan’s reference rate at 6.4990 per dollar, the strongest level since July 2005. The currency is allowed to trade up to 0.5 percent on either side of the official rate.

Chart from Yahoo

If China continues to appreciate her currency then this means less recycling of her US dollar reserves into US treasuries.

But hot money flows, despite China’s capital controls, will still be a factor to China’s predicament.

The US Global Investor writes,

An influx of global funds seeking short-term returns, or hot money, into China moderates the impact of monetary tightening and increases inflationary pressure. The CEBM Group estimated the total amount of hot money influx was Rmb 930 billion in the first quarter, marginally above the historical high of Rmb 921.9 billion reached in the first quarter of 2008. This quarter’s hot money could offset the impact of 150 basis points of the required reserve ratio hike.

China’s rising interest rates and expectations of further appreciation could likely fuel more hot money flows.

All these attempts to macro manage China’s economy will eventually lead to adverse unintended consequences.

And in contrast to the consensus, once a bust or a bubble burst should occur, then I expect the yuan to suffer from a decline as consequence to the exodus of hot money.

That’s the scourge of the paper money system.