China’s State Administration of Foreign Exchange, SAFE, has issued a statement that beginning April 1, 2011, banks will be permitted to trade forex options among themselves and to sell options to customers, who may resell them as long as “they are trying to exit from an option bought earlier,” according to The Wall Street Journal. The effect of this new rule will be to speed up (slightly) the appreciation of China’s yuan.
Permitting the country’s exporters to purchase forex options gives the companies a way to hedge against a too-rapid rise in the yuan. That hardly seems possible, given the excruciatingly slow pace at which the currency has grown over the past few years. But now that Chinese manufacturers can purchase protection against a rapidly rising yuan, the government may see fit to let the currency appreciate more quickly.
While the SAFE paints this move as a requirement for making the yuan a more international currency, US Treasury Secretary Tim Geithner told a US Senate committee that China has finally come to the conclusion that it needs to let the currency appreciate if the country is going to be able to cope with rising inflation. Geithner noted that when inflation is factored in, the yuan is appreciating at “roughly 10% a year or more,” reports the WSJ.
As China tries to cool off inflation running at an annual rate of around 5%, it is capping prices on some foods, raising wages, and instituting more capital controls. We have also written about other changes the government has made as it works toward bringing inflation down.
As the yuan appreciates and wages and other costs in China rise, Chinese goods could lose some of their competitiveness in global markets. That brings down the country’s trade surplus, and also lowers the trade deficits of some of China’s trading partners, like the US. This is clearly good for the US, and ultimately good for China.
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