The renminbi’s appreciation from 2005 to 2008 was not only a response to the weakness of the US dollar, but formed part of a broader policy to slow an export-led economy.
The dollar is again weak, but economic conditions at the start of 2010 are very different in all other respects.
Chinese investment has grown explosively since the start of 2009, but it is only in the last quarter that capital spending has started to gain breadth with residential construction accelerating.
Investment in light industry, though returning, is at an earlier stage still. Inflation is negative and, thanks to spare capacity overseas, will remain low in 2010.
Because China’s stimulus has happened when the rest of the world is still troubled with surplus capacity, it is causing rapid swings in trade. Inflation is being kept low by virtue of rising imports.
This will continue in 2010, and because rising imports are to Chinese policy-makers much more benign than rising inflation, measures to slow growth will remain gradual.
Directed investment has already started to slow and will continue to do so, but currency appreciation, especially while exports remain weak, will be a last rather than a first solution.
And China has a long history of dealing with balance of payments surpluses through sterilised intervention. There is no reason to think 2010 will be different. On the contrary, rapid import growth means that the effort to resist currency appreciation will diminish.
Hot money inflows will also weaken as growth rates in the rest of Asia play catch-up with China. Monetising and then sterilising will be easier in 2010 than it has been in 2009.
At the very least currency appreciation will be postponed until late in 2010 when the private investment cycle has taken over from government and the surplus capacity that is keeping a lid on inflation has been fully cleared.
But by this time China will be running trade deficits, not surpluses. Our central case is that the exchange rate remains unchanged to the end of 2010.