Photographer: Tomohiro Ohsumi/Bloomberg

One Thing China Got Right

Stocks plunged, monetary policy wavered, but Beijing finally fixed the "fixing."

China's management of the world's second-largest economy hasn't gone swimmingly of late, but authorities have succeeded in one vital though little-noticed mission. They've closed the gap between the market value of the yuan and its official daily value, known as the "fixing."

Matching the fixing of the Chinese currency with its market rate is an essential step before the International Monetary Fund will consider making the yuan one of its reserve currencies, along with the U.S. dollar, the Japanese yen, the British pound, and the euro, said Marc Chandler, a senior vice president and head of currency for Brown Brothers Harriman in New York. Raising the yuan's profile remains a priority for the Chinese government, even during the current market turmoil. In its bid to become a world financial power, Beijing is playing a long game.

This chart shows that late in 2014 a gap began to open between the market rate of the yuan and the fixing, which is announced daily by a branch of the People's Bank of China, the nation's central bank. That worried Chinese authorities, because according to IMF rules the price set in the fixing is supposed to be the one at which market transactions can and do occur. It wasn't.

In the chart, the upper line is the market rate for the yuan; it's expressed in yuan per dollar, so the higher the line, the weaker the yuan. The lower line is the daily fixing.

The chart shows that the yuan was weaker than the fixing—that is, weaker than the Chinese government wanted it to be. The gap was never big, always inside the plus or minus 2 percent band within which the government allowed the yuan to fluctuate daily.

Then came Aug. 11, when China abruptly changed the fixing, weakening the yuan by about 1.8 percent. The move seems to have been more an acknowledgment of the yen's weakness in the market than a bid to increase China's competitiveness. But currency traders, guessing that Beijing would weaken the yuan more to stimulate exports, pushed the rate even lower.

Chinese authorities didn't try to hold the line with the fixing. Instead, they let the official rate follow the market rate precisely. If they had fought the market by setting a stronger fixing, they surely would have lost, and damaged the nation's bid to make the yuan a reserve currency.

That may not look like a big deal to Americans, who are used to a floating currency. In Chicago, Chandler noted, currency futures are traded right next to livestock futures. The Chinese, in contrast, have a tradition of a highly managed currency. "Most countries don't accept in principle that currencies should be traded like bacon," Chandler said. 

"Nobody knows officially how China gets to its fixing. It's still a black box. It says it takes prices from many banks, more than a dozen, including foreign banks," but there seem to be other considerations at work, he said. "My sense is that they’ve engineered this so it looks right. Now that it looks right, they'll engineer the substance behind it."

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