China Revaluation

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Revaluation

Impact

Forecasts

With increasing pressure to revalue the yuan, China could choose one of three options:

	Free-Float (Least Likely)
	Pegging to a Basket of Currencies
	Widening Trading Band

Pegging to a basket of currencies (Possible)

The People's Bank of China has suggested several times that it was considering pegging the yuan to a basket of currencies. Under such a system, the yuan would be fixed to a mix of foreign currencies, weighted according to the issuing country or region's trade volume with China. This would allow for some flexibility against the dollar and discourage any one-way speculative bets. Most importantly, it would represent a more proper value for the CNY. It would also make China less sensitive to one country's monetary policy. By pegging the yuan to the dollar, China has basically foregone all monetary power to the US Federal Reserve. With a basket of currencies, China would be able to juggle the weight of each currency so as to obtain a mix more in line with its monetary goals. The Japanese yen and Euro would benefit most directly by such re-weighting since along with the US, they represent China's most important trading partners. Furthermore, a revaluation of the Yuan will force Chinese policy makers to sell a least part of their US dollar holdings and buy euros and/or yen. Currently there is a growing shift by different countries to diversify their foreign exchange reserves away from dollar and including an increasing amount of euro's in their mix of currencies. So far we know that Russia will be readjusting their dollar denominated reserve holdings. South Africa and India are also suspected of dumping US treasuries. According to the latest Bank of International Settlements report, oil exporters have reduced their dollar holdings over the past 3 years. Central banks in the Middle East have exchanged some dollar reserves for euros to avoid incurring losses related to

the slide in the dollar. Although the euro was only launched in 1999, it has since become the world's second most popular reserve currency. As time passes, we expect more central banks to hold an increasing number of euros as they adjust their reserve holdings to reflect their trade flows. For China, their mix will continue to include the dollar, but by a diminished capacity. However, they are also expected to increase their holdings of Japanese yen and the euro.

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