A DIALOGUE OF THE DEAF ON THE YUAN / THE WALL STREET JOURNAL ( HIGHLY RECOMMENDED READING )

HEARD ON THE STREET

DECEMBER 5, 2011, 6:04 A.M. ET

A Dialogue of the Deaf on the Yuan

By TOM ORLIK

When it comes to the yuan, politicians say one thing and the market says another.

In China, confidence in yuan appreciation has evaporated. The yuan trades in a tightly controlled band, with space to move just 0.5% above or below the central parity with the dollar on any given day. Four times in the last four trading sessions it has traded down to the bottom of its band.
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There's more negative sentiment in the yuan forward market, which is pricing in 0.7% depreciation against the dollar in the year ahead. The offshore yuan, which is freely traded, has fallen below its onshore cousin. Signs that speculative capital has started to leave China also suggest investors no longer regard the yuan as a one-way bet.
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This doesn't mean investors believe the Chinese currency is actually overvalued. Rather it reflects the view that the Chinese government is poised to slow the pace of appreciation. There's good reason for that. Exports are already falling and will fall more in the months ahead as the euro-zone crisis rumbles on. The high inflation that drove Beijing to more rapid appreciation in the first half of the year is in remission.
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The U.S. has done pretty well on the exchange rate in the past year. Nominal appreciation of 5% plus higher inflation in China than the U.S. gives real appreciation of around 7% - not too shabby. But don't expect to hear that view in Washington, with unemployment still high and politicians gearing up for an election year.

Signaling the resumption of hostilities, U.S. President Barack Obama said in November that the yuan remained as much as 25% undervalued. Republican rivals, meanwhile, are taking the administration to task for failing to extract more concessions from Beijing. Republican presidential candidate Mitt Romney is promising to designate China a currency manipulator and impose countervailing duties on Chinese goods. With his main rivals on the offensive, it will be difficult for Mr. Obama to appear weak on the issue.
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The stage is set for a difficult 2012 in U.S.-China economic relations. Washington will raise the rhetorical temperature. But if Chinese exports continue to deteriorate don't bet on that having any impact on Beijing's plan for the yuan. Real appreciation of 7% in 2011 might not have been enough to make U.S. politicians happy. In 2012, that number could look like a distant dream.
 
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