In a few words, the Chinese authorities unleashed something akin to euphoria in financial markets and among economists. It was, said the People's Bank of China, the central bank, "desirable to proceed further with reform of the renminbi exchange rate regime and increase the renminbi exchange rate flexibility".
With that, stock markets around the world were off to the races. With that, the Chinese changed the atmosphere around the forthcoming G20 meeting of the world's largest economic powers. And with that, it appeared we might have found the key to resolving some of the most intractable economic imbalances of our time, imbalances which underlay the credit crisis and threatened to ignite a devastating trade war. But hang on just a minute.
The announcement – which came late on Saturday, and which was utterly unexpected, given that Chinese officials had spent the previous week defending their existing policy – means that the renminbi will be allowed to rise in value against the dollar, after two years when it has been pegged to the US currency. That brings much greater flexibility into the global financial system, but much will hinge on what the Chinese central bank decides to do with this flexibility. And ever since the announcement, officials have been working to limit expectations. Three days on, a more balanced view has emerged.
"The announcement by the People's Bank of China is vague on what will happen next," said John Higgins at Capital Economics. "Those now expecting a large appreciation against the dollar, and for this to boost the global economy and ease trade tensions, will ultimately be disappointed. For a start, the appreciation of the renminbi against the dollar is likely to be small, perhaps just a few per cent over the remainder of the year. What's more, even a much bigger move would do nothing to boost the world economy without additional steps to increase aggregate demand – which may follow, or may not."
With the Chinese economy on the brink of overtaking Japan's as the second largest in the world, the value of the renminbi is of crucial importance, but the cautious Communist regime, now into its fourth decade of economic liberalisation, does not let financial markets set the exchange rate. It has been set centrally – and at a level below where it would be set by the market – so as to stimulate the development of manufacturing and keep Chinese exports cheap. In the US, the policy is routinely damned by politicians as currency manipulation and blamed for the withering of American manufacturing. More widely, it is seen holding back the growth of domestic demand in China. A surge in consumption by the Chinese middle class, if imports were to become cheaper, could aid recovery in advanced nations, which would gain a vast new export market.
This was the basis of the euphoria this weekend. The regime in China is alive to the need to reorient its economy away from exports over the long run, but divided about how fast to move. Between 2005 and 2008, the last time the currency was allowed to float against the dollar (in a controlled fashion, with daily moves limited to a narrow range relative to a basket of global currencies), the renminbi rose more than 20 per cent, but the peg was reintroduced in 2008 to help China weather the credit crisis. Now the 2005 policy looks like being restored.
Mike Lenhoff, at Brewin Dolphin, peppered his analysis with exclamation marks. "We could be staring at the prospect of the 'great global stimulus'!" he wrote yesterday. "China's readiness for further exchange rate reform is just what is needed. Together with interest rates on hold at the major central banks it provides another means of reflation for the global economy ... Any appreciation in the renminbi from here will further enhance the respective competitive positions [of the euro and sterling] and gradually that of the dollar itself."
The G20 meeting which begins this Saturday was looking likely to be dominated by the issue of China's currency, and the timing of its policy change was no coincidence. With the passing of the credit crisis, economists had expected a return to the managed float at some point, but had pushed out the date because of the turmoil in the eurozone and the threat that austerity measures would hurt global demand for Chinese manufacturing goods. In the end, the pressures of diplomacy won out. The US has in fact been muting its criticism of China, or at least the Obama administration has. In April, Tim Geithner, the US Treasury Secretary, refused to sign off on a report that could have labelled China a "currency manipulator" and triggered sanctions. But pressure has been rising on China from elsewhere, and there has been public criticism of the undervalued renminbi from Brazil and India. Now, with China signalling its willingness to contribute to a rebalancing of the global economy, pressure is likely to switch to other export-led economies, particularly Germany, which could do more to stimulate global demand by encouraging domestic consumption.
It will not, however, be the end of the pressure on China. Members of Congress have always been more aggressive on the issue than the White House, and senior figures said immediately that they would renew their push to have China labelled a currency manipulator. They cited comments from Chinese officials which in effect ruled out an immediate, one-off upward revaluation of the renminbi, comments that filtered through the financial markets yesterday and gradually eroded the early spikes in stock prices and other risky assets.
"China has made it clear it is not moving to a floating exchange rate, which really would have been a significant move," said Ted Scott, at F&C in London. "The move has limited economic significance, especially in the short term while the global economic environment remains so uncertain. The Chinese have an intrinsic fear of reversing the economic model that has helped generate the spectacular growth in recent years and has served them so well in the recession. Politically, it is astute as it removes the growing possibility of a trade war while hardly undermining China's export industry because of the gradualist approach. The euphoric reaction is understandable but should not be overstated."