Managed Floats

The big news in the financial markets, of course, is that Chinese has moved from a pegged exchange rate to a managed floating exchange rate.  OK, first, EVERYBODY PANIC.  Now that that’s out of our system, let’s be clear that a managed float is a peg that the government allows to fluctuate a little bit.  When push comes to shove, it is a peg.  In the event of speculative pressure against the yuan, the People’s Bank of China (their central bank, their Fed) will defend it just like they defend a hard peg.  In fact, the tools for managing a managed float vs. a peg (or a currency board or whatever) is precisely the same.  And while the PBC has announced that it has moved to a managed float against an "undisclosed basket of currencies", this reminds me of SE Asia before the Asian Financial Crisis, where this "basket of currencies" was composed of the 99% dollars.  I again think that people just like the term "managed float" instead of "peg" because they think that "float" sounds good.  This is a strategy on the part of the Chinese to buy a little time.

From the prospects of the US, there has been a little bit of an appreciation of the yuan, but not much.  There will not be much of an effect on either countries in the short term.  In the long term, this could signal changes to come, which would be more important.  I think that the conservative and liberal consensus on this one is that this is not enough of a revalution to solve any of the problems that the US has been, perhaps correctly, complaining about with regards to China.  There is also the nagging problem of what would happen if China actually let the yuan float, something which some rogue economists–mostly liberals, but some conservatives who are not in policy positions too–seem to believe could be tough for the US.

What has been lost in the brouhaha is that Malaysia also un-pegged its currency and moved to a managed float at the same time.  Again, EVERYBODY PANIC. This is a fascinating development.  People have been wondering when Malaysia was going to un-peg its currency (until yesterday, RM3.8 = US$1), which was pegged on September 1, 1998 along with the imposition of capital controls as a way to get out of the Asian Financial Crisis.  The plan looks to have been on the drawing board for some time, but still, the co-incidence of Malaysia’s decision to un-peg with China’s decision–like, three hours later–suggests something that students of international economics rarely discuss.  Why would China’s decision affect Malaysia’s decision?  Do we often find such regional contagion in exchange rate policy decisions?  One idea is that Malaysia and China might be export competitors in certain sectors.  If the Chinese allow dollar-denominated price of their goods move up, then Malaysia can do the same thing, with the effect that their competing dollar-denominated exports get just a little bit more expensive as well.  There might be a decision that they can offset the implicit increased revenue from a Chinese appreciation (because more people would by Malaysian exports) by greater revenue from higher prices that do not drive all of their customers away.  But really, I have no idea.

The ringgit has appreciated in the past day from 3.8 to the dollar to 3.775 or so.  It’s only a bit of an appreciation, but our purchasing power here just declined a little bit.  And lest you Americans reading this think that this makes no difference to you, you might be interested to know that Malaysia is the US’s 10th largest trading partner.  Semi-conductors and microchips just got that much more expensive for you.

While I have not been following developments in China, the Malaysian financial markets demonstrate how close a managed peg is to a real peg.  Currency traders and investors moved into Malaysia en masse, pushing pressure on the ringgit up to what should have been about 3.6 to the dollar, by most estimates.  Bank Negara Malaysia (the central bank here) intervened to keep the ringgit lower, just like it would have done with a secular increase in capital flowing to Malaysia under a hard peg.  So you see, not much of a difference at all.