The Chinese government put a jolt in international markets over the weekend, by announcing that it would increase its currency's "exchange rate flexibility." In essence, this means the yuan will no longer be pegged to the dollar. But as U.S. Treasury Secretary Timothy Geithner said yesterday, no one yet knows to what degree the People's Bank of China will let it float.
Despite the PBOC's warning that "the basis for large-scale appreciation" of the yuan doesn't exist, most believe the currency will begin at least a slow appreciation against the dollar. This has heartened the U.S. and many other countries, who felt the artificially low currency gave China an unfair trade advantage.
For a little more perspective of what this means for investors, I asked Global Gains co-advisor Tim Hanson for his take on the weekend's news. Tim and his team will be back in China soon for their yearly research trip, in search of the best stock values in the world's most populous country.
Rex: Tim, there's a little excitement in the air ahead of your upcoming trip to China! Why did China peg the yuan to the dollar in the first place, and why are officials "unpegging" it now?
Tim: The reason China enforced a fixed-exchange rate is because the government wanted a predictable economic system that would allow the country to build a massive export sector. By pegging the yuan to the dollar, Chinese manufacturers were able to promise stable pricing that generally undercut competitor nations and allowed the country to achieve rapid economic growth on the back of its export sector. The reason the government is now considering unpegging the currency is because it's come under significant political pressure from countries such as the U.S., as well as others in their region, who think the fixed-exchange rate gives China an unfair advantage.
Rex: Most are anticipating an upward move for the yuan now, though the Chinese central bank says there's no basis for a "large-scale appreciation" of the yuan. What does it mean for investors? What types of companies might benefit?
Tim: The losers here will be Chinese manufacturers who compete on cost, because their cost of labor, in dollar terms, is about to go up. Companies that fit this bill, such as Winner Medical
Thanks, Tim, we look forward to reading your real-time reports from your upcoming trip.
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Fool analyst Rex Moore and Global Gainsco-advisor Tim Hanson own no companies mentioned in this article. Winner Medical Group is a Motley Fool Global Gainschoice. The Fool owns shares of China Mobile. The Motley Fool has a disclosure policy.