BEIJING – On October 26, the renminbi’s spot exchange rate against the US dollar reached the upper limit of its floating range for the second consecutive trading day. The rise began when the trading band for the renminbi’s dollar exchange rate was widened to ±1%, and has now reached an all-time high since 1994’s currency reform. With little sign of improved economic fundamentals, rapid currency appreciation is a potentially dangerous development for China – in part owing to the risk of an abrupt and painful reversal.
The renminbi’s rise over the past month can be attributed to greater global liquidity since the start of the third quarter, as policymakers have responded to the eurozone’s sovereign-debt crisis and stagnating output. Indeed, according to Morgan Stanley, monetary authorities in 16 of the 33 countries that it follows – including seven of ten advanced-country central banks and nine of 23 central banks in emerging markets – have either cut their benchmark interest rate or lowered reserve requirements.
After two rounds of quantitative easing (QE), the balance sheets of the European Central Bank and the United States Federal Reserve have grown to €3.2 trillion ($4.1 trillion) and $2.9 trillion, respectively. The ECB’s new outright monetary transactions (OMT) program in secondary sovereign-bond markets, and the Fed’s open-ended “QE3” continue this trend, while the Bank of Japan has expanded its asset-purchase program for the eighth time.
The spillover from the developed countries’ latest round of QE is beginning to show up in emerging markets, where nearly a year of short-term capital outflows has given way to a new wave of short-term inflows. With US domestic bond yields continuing to fall and US equities reaching an upper price limit, owing to the real economy’s sluggish recovery, more money is expected to flow to commodity markets and higher-yielding emerging countries. Given China’s adherence to a stable monetary policy, the renminbi has become a more attractive asset to hold.