China's Self-Interest Will Change Its Currency Policy (Shocking, I Know)

Most of the mainstream reporting about China's response to all of this awful market turmoil has focused on the Chinese government's finger-wagging about American fiscal profligacy.  This, of course, is laughable considering China's own, ahem, precarious fiscal situation, but there is some real news to report about the impact of the current US fiscal mess on China - it could actually do what years of worthless political bluster about China's currency in the United States never, ever had a chance of achieving.  This interesting Reuters report (h/t Lee Miller) has the details:

Chinese editorials flaying Washington for fiscal recklessness over its debt dramatics and downgrade mask a growing unease in Beijing: a fear that China's own economic policies are shifting too slowly.

Interviews with a dozen high-ranking Chinese officials and government economists revealed frustration with China's self-imposed fetters to the U.S. dollar and louder calls for a change, but no clear short-term plan to break free.

The obvious answer -- allowing the yuan to rise more rapidly -- carries economic and political costs that China is probably not yet prepared to pay.

One idea that appeared to be gaining some traction in Beijing is to loosen restrictions on Chinese businesses and citizens investing abroad. That would help to reduce the build-up of cash inside China.

But it would only marginally trim China's U.S. exposure. An estimated two-thirds of China's $3.2 trillion in reserves is invested in U.S. dollar-denominated assets such as Treasuries, and the pile of cash grows each month thanks to a heavy trade surplus.

Standard & Poor's stripped the United States of its prized AAA rating on Friday, citing the government's rising debt burden, drawing a blast of criticism from official China media.

Some officials who spoke to Reuters sounded resigned to their fate, acknowledging that there is no viable alternative to investing in U.S. Treasury debt.

But others saw the U.S. debt debacle in recent weeks as just the sort of shove Beijing needs to speed up domestic reforms.

"We need to diversify to the greatest extent possible," said one People's Bank of China official who spoke on condition of anonymity because he was not authorized to speak to the media.

"China's position has always been very clear," he said.

"First, we'll demand strongly that the United States strengthen its self discipline -- they can't just keep issuing debt without limit. Secondly, we need to speed up the pace of our domestic economic transformation and reduce our accumulation of foreign exchange reserves."...

China's ruling Communist Party has long been reluctant to take any steps that might jeopardize the fast economic growth that has helped it stay in power, and generally sees a quick revaluation of the yuan as too risky.

Still, the fact that a well-known former Chinese official is publicly calling for such a sharp policy shift shows that Beijing is ripe for change, whether quicker liberalization of the yuan or a more decisive shift away from exports and toward domestic consumption....

"The downgrade in the U.S. credit rating gives China's government an extremely rare opportunity to reconsider their development strategies," said Zhang Ming, an economist from the Research Center for International Finance, a state think tank.

Those of us on the "sanity" side of the US-China currency debate have long argued that (i) floating the Yuan is strongly in China's own interests; and (ii) internal pressures, not silly political chest-thumping or self-defeating American protectionism, will finally push the Chinese government to amend its currency policies.  It's far from certain that the latest troubling events in US and global markets will finally convince the Chinese to act, but it's unquestionable that this latest Reuters story further supports our two main arguments.