The perception that the Chinese Yuan is an undervalued currency is beginning to change could have significant implications, not just on China but on the global economy, writes Ted Scott, director of global strategy at F&C, in a recent note. Below is an extract of his thoughts.

 One of the axioms within foreign exchange markets in recent years has been that the Chinese currency has been undervalued. To prevent the Yuan appreciating against the US Dollar, China has had to persistently intervene in the foreign exchange market.

This is a controversial policy that has been fiercely criticised by the US, which has accused China of artificially manipulating its currency to the benefit of its exporters and to the cost of US domestic companies.

In effect, the US has maintained that China has been stealing American jobs by flooding its country with cheap imports.

The perception that China has an undervalued currency is, however, beginning to change and, if correct, could have significant implications for not just China but for the global economy.

Recently, officials from the Chinese central bank, the People’s Bank of China, suggested that the Yuan is no longer undervalued after six years of gradual but limited appreciation. 

Over the next few years the current account is likely to move into a deficit as the trade surplus continues to fall and the capital account is liberalised allowing outflows.

This is part of the natural evolution of a fast growing economy, but the authorities have a major challenge in trying to rebalance growth away from exports and fixed investment, on which it has become too dependent, and towards domestic consumption while avoiding a hard landing.

For other countries the mutually beneficial relationship, whereby China has generated huge export growth and its trading partners have bought cheap imports, is now over.

The price of Chinese imports has risen and with the current account moving towards recording a deficit the Yuan is no longer undervalued. For the US, in particular, this poses a major risk because China may be forced to reduce its holdings of Treasury bonds further and in increasing size.

If China falters in its efforts to rebalance its economy it may be tempted to devalue the Yuan as a way to stimulate export growth.

This is something that financial markets have not seriously considered yet but which we think is a real possibility in the next few years.