China’s currency: what’s news?

From the “What’s News” column of Saturday’s Wall Street Journal: “China’s decision to liberalize its foreign-currency regime is unlikely to result immediately in a strengthening of the yuan. (Article on Page A4)”

And this is news? Am I missing something, or should the story have been, “The effect of China’s relaxation of capital controls has been widely misunderstood by potential Wall Street Journal readers.”?

The article is quite clear about what China did: “China’s central bank announced measures that will make it easier for individuals and companies to buy foreign currency – and then for the first time to invest those funds overseas in stocks and bonds through banks and brokerage firms.” The substance had already been reported in Friday’s “What’s News” column (along with any number of other places in the financial press): “China will allow companies and individuals to make significant investments abroad for the first time…”

In other words, people who previously had to hold their assets in yuan-denominated form will now be allowed to sell those yuan. (I know that’s an oversimplification, but that’s the gist of it.) OK, here’s a quiz: what happens to the price of something when people sell more of it? Does the price go up? (It’s been a few years since I was in school. Maybe I’ve missed some of the latest thinking on this topic.)

Assuming economics has not been completely turned on its head in the last 12 years (and that the yuan is not a Giffen good), it seems to me that the relaxation of capital controls cannot result in a strengthening of the yuan. What it will do, of course, is reduce the required amount of intervention by the Chinese to support the dollar’s current exchange rate against the yuan. Think of it as partially privatizing the job of supporting the dollar.

What the Chinese apparently hope is that, eventually, investment abroad by Chinese individuals and businesses will become so popular that the job of supporting the dollar (or other foreign currencies) can be “fully privatized.” At that point, the intervention will no longer be necessary, the currency can be made fully convertible, and nobody can continue to accuse the Chinese of manipulation. Some economists think that might actually happen.

Well, a few economists think so, anyway. Most, however, think that the Chinese will have to allow the yuan to appreciate significantly before they can stop their intervention. It is unclear whether yesterday’s action will hasten or delay such a change.