A "baby step", but a step in the right direction

------By Justin Lowes

July was another fantastic month for global markets. All major markets posted gains of 3 percent or more. France and Germany rose in excess of 6 percent, as did India, Singa-pore and Hong Kong. South Korea advanced by around 10 percent. The Bank of England low-ered interest rates for the first time in two years. Bank of America described the UK economic slowdown as "a perfect soft landing”. Business con.dence advanced in Germany, although con-sumer sentiment fell.

On July 21, China announced that the RMB's peg to the US dollar, in place since 1994, would be replaced by a "Managed .oating exchange rate re-gime" against a "basket of currencies”. At the same time, the value of the RMB would be adjusted from 8.28 to 8.11 to the US dollar - an increase in value of approximately 2.1 percent. The RMB would be allowed to move by +/-0.3 percent against the US dollar each day, with the People's Bank of China announcing the closing price of the RMB against various currencies after the closing of the market on each working day. The exact makeup of the "basket of currencies”, plus the weighting of each currency within the basket, was not disclosed.

US politicians welcomed the news of the RMB's revaluation as a good “.rst baby step”. Although far short of the revaluation called for by many in the US, the move is seen to have opened the door to a gradual strengthening of the RMB's value.

In the short-term it appears that China has played its hand extremely well. The move will reduce some of the pressure that was building, without committing the government to a set policy at this time. The framework allows China to assess the impact of a strengthening RMB and one tune future changes depending on events. Although the Chinese government claims that there will be no further substantial gains in the RMB's value, most commentators assume that the RMB will increase in value by another 5 -10 percent over the next twelve months.

Assuming that the RMB does continue to gradually appreciate in value, we may well now see a protracted and gradual decline in the value of the USD measured against a global basket of currencies. Over the past few years, much of the falling value of the USD has been borne by west-ern currencies. If the RMB is allowed to gradually appreciate, Asian central banks wil l reduce their rate of purchase of US assets, thereby allowing their currencies to appreciate as well.