External Pressure On Yuan Peg Will Likely Ease

Tensions over China’s U.S. dollar peg have risen recently because of the strong growth rate in China and because of the dollar's decline against other currencies (which have caused the yuan to decline against these currencies by a similar amount).

However, because of two factors, external pressure could ease. First of all, trade data shows that the Chinese trade surplus is already dropping as Chinese exports dropped 1.2% while imports rose 26.7%.

And secondly, the dollar bear market seems to have ended. If, as seems likely, the dollar starts to appreciate in value this will also cause the yuan to appreciate.

On the other hand, internal pressure for yuan appreciation or some other form of monetary policy tightening is growing given the abnormally high money supply growth and the increase in output growth and inflation this have generated. Combined with measures to deter "hot money" inflows from taking advantage of yuan appreciation that would be the most effective way of reining in the expansion of the central bank balance sheet and money supply that we are now seeing. Higher reserve requirements could however also be implemented.