Stock exchanges and currency markets are moving so fast that it’s difficult to keep up with the swings – but the root of the current volatility is the Chinese renminbi.
Markets have not adapted to doing business the Chinese way.
The renminbi was recently voted a currency with special drawing rights. The rights are like an international currency and are allocated to countries according to the quotas they pay the IMF.
The value of special drawing rights is calculated from the price of the limited number of currencies underpinning the rights. These currencies were the US dollar, Japanese yen, Sterling and the Euro.
Now the renminbi is snuggling alongside these special global currencies.
Finding a level
To become a special drawing right currency, the People’s Bank of China had to agree to float the renminbi so the markets determined the value rather than the Chinese government or state bank.
The current volatility on the world markets results from a pegged currency suddenly freed to find its own level.
The money markets are used to central banks such as the US Federal Reserve, the Bank of England and European Central Bank regularly updating them with policy announcements and explanations.
The People’s Bank of China does not operate like this.
Working with each other
As the markets have seen, the bank will act without warning to change rates and this volatility injects uncertainty into the minds of traders who are never quite sure how the renminbi will respond.
The dollar, pound, yen and euro are much more predictable and transparent and traders have more confidence in them as a result.
Both sides have to learn to work with each other, and the best guess is they will over time, but in the getting to know you stage, they are unsure of each other’s intentions and make decisions to protect their own positions.
One theory is the Chinese are deliberately creating doubt in the markets to protect the Shanghai stock exchange and the renminbi from speculators.
If that’s the case, the plan definitely seems to be working from what the markets have experienced in the past few days alone.