Undervalued RMB? Are Chinese products going to be more expensive?

Back in 2005, China decided to stop pegging the RMB to the dollar.

"After China abruptly allowed its currency, the yuan, to appreciate by a modest 2 percent on July 21, the trading price between US dollars and yuan can be fluctuated within 0.3 percent in inter-bank foreign exchange market, and the trading price between non-US dollars and yuan can be fluctuated within 1.5 percent."

This rate of change of only 0.3% apparently didn't result in a fast enough change to satisfy US law makers who are screaming for a revaluation of the RMB.

"China will widen the floating band of yuan against US dollar for daily spot trading on the interbank market from 0.3 percent to 0.5 percent as of May 21, the People's Bank of China, or the central bank, announced on Friday."

As you can see from this Yahoo Finance chart, the RMB has gone from trading 8.3 RMB to the dollar to 7.6 RMB to the dollar - a 9.2% change starting with the July 21, 2005 appreciation.



According to some sources, the RMB is still undervalued.

"Thus, to make the before mentioned equilibrium of underlying current account
balance and the net capital flows to be achieved a 15 to 30 percent appreciation of the Chinese RMB would be needed."

If 30% is the right number, then you should be able to buy something like 5.85 RMB with a US dollar. Considering that the float was limited to 0.3% per day between July 21, 2005 and May 21, 2007, and removing the initial 2% adjustment, the RMB has appreciated by 7.2% over 669 days. If we remove 1/4 of those days for holidays/weekends/etc, then it has changed 7.2% over 502 days.

Theoretically, the RMB could have appreciated as much as 350% over that timespan.

(1+.003)^502-1 = 3.50

Yet it only changed by 7.2%. Why is that?

Over the next year, saying there are 200 trading days and a peak of 0.5% appreciation per day, we could see a 171% price appreciation against the dollar.

If the RMB is truly undervalued, this is a case of artificial interference by the Chinese government with the exchange rate. They are propping up the dollar and keeping the RMB low.

Why would they do that?

"U.S. footwear and apparel firms imported over $30 billion worth of footwear and apparel from China. U.S. imports from China account for over 85 percent of all shoes and over 25 percent of clothes sold in the United States."

In 2006, the United States imported $287.7 billion dollars worth of goods from China. What do you think will happen if it suddenly costs 30% more to buy all those goods?

China can't keep propping up the currency forever. Eventually, their demand to purchase US treasuries will exceed the amount available. I think we're seeing signs of this already with their $3 billion dollar investment in Blackstone.

I predict we're going see another 10% appreciation this year, give or take 3%. Thus, by July 9, 2008, I predict the exchange rate will be 6.9 RMB to the dollar.